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PROFIT  AND  WAGES 


PROFIT  AND  WAGES 

A  STUDY  IN  THE  DISTRIBUTION 
OF  INCOME 


BY 

G.  A.  KLEENE 

PROFESSOR   OF  ECONOMICS,  TRINITY  COLLEGE,  HARTFORD,   CONN. 


THE  MACMILLAN  COMPANY 
1916 


COPYRIGHT,  1916, 
BY  THE  MACMII^AN  COMPANY. 


Published  November,  1916. 


PREFACE 

Though  its  abstract  and  intricate  character  has 
made  it  an  esoteric  discipline,  the  theory  of  distribution 
demands  the  consideration  of  every  serious  student 
of  affairs.  No  fundamental  conception  of  our  most 
important  economic  problems  is  attainable  except  in 
relation  to  the  factors  governing  the  distribution  of 
income.  Unless  resigned  to  superficial  views,  we  cannot, 
therefore,  maintain  a  passive  attitude  toward  the 
unsettled  state  of  economic  doctrine.  In  the  face  of 
continued  failure,  neither  discouragement  nor  scepticism 
should  halt  the  struggle  for  a  definite  and  accepted 
theory  of  distribution.  May  the  publication  of  this 
book  contribute  something  to  the  will  to  master  the 
difficulties  of  the  problem. 

The  author  is  under  obligation  for  permission  to 
use  parts  of  an  article  published  in  the  Quarterly  Journal 
of  Economics  for  February,  1912.  He  is  also  under 
great  obligation  to  his  wife  for  criticism  and  assistance 
in  revision  and  proof-reading,  and  to  his  friend,  Mr. 
Edward  Porritt  for  helpful  counsel. 


TABLE  OF  CONTENTS 

CHAPTER  I.     INTRODUCTION. 

Definitions  of  distribution  and  income,  i.  Concept  of 
psychic  income  not  of  service  to  present  inquiry,  i.  Differ- 
ences in  method  of  investigation  according  as  the  subject 
is  the  distribution  of  wealth  or  the  distribution  of  income, 
2.  The  method  of  economic  theory,  3.  Hypothetical 
assumptions  to  be  made  and  limitations  of  our  inquiry,  5. 
Reasons  why  our  inquiry  must  be  largely  critical,  7. 

GENERAL  OUTLINE  OF  SUBJECT  —  The  parties  who  share 
in  the  total  product  of  society,  8.  Different  concepts  of 
capital,  9.  Capital  regarded  as  subsistence  advanced  to 
labor  the  most  fruitful  concept  for  the  theory  of  distri- 
bution, 1 1 .  Distinction  between  differential  and  marginal 
income,  13.  First  stage  in  our  analysis  of  distributive 
process  the  separation  of  differential  gain  from  marginal 
income,  15.  The  second  stage  the  division  of  marginal 
income  between  capitalist  and  laborer,  16.  Three  different 
methods  by  which  it  has  been  attempted  to  explain  this 
division,  18. 

CHAPTER  II.     BOHM-BAWERK'S  THEORY  OF  INTEREST. 

Reasons  for  beginning  a  critical  study  of  the  problem 
with  Bohm-Bawerk's  theory,  20.  Bohm-Bawerk's  funda- 
mental concept,  21.  Three  reasons  for  preference  for 
present  over  future  goods  given  by  Bohm-Bawerk,  22. 
The  technical  superiority  of  present  good  no  direct  ground 
for  preference  for  present  goods  but  possibly  an  indirect 
one,  25.  Bohm-Bawerk  failed  to  give  a  unitary  explanation 
of  interest,  28. 

CHAPTER  III.     THE  TIME-PREFERENCE  THEORY. 

Attempt  to  base  interest  theory  on  first  two  grounds  of 
preference  mentioned  by  Bohm-Bawerk,  29.  Do  these 
play  an  actual  part  in  saving  and  investment?  30.  Defini- 

I 


TABLE  OF  CONTENTS 

tion  of  time-preference,  33.  Transition  from  earlier  idea 
of  abstinence  to  that  of  time-preference,  35.  No  post- 
ponement of  consumption  of  capital  in  actual  investment,  36. 
Is  there  an  exchange  of  present  for  future  goods?  39.  A 
less  objectionable  form  of  time-preference  theory,  43. 
The  consumption  loan,  45.  The  purchase  of  durable 
goods  not  explained  by  time-preference  theory,  46.  The 
reductio  ad  absurdum  of  the  time-preference  theory,  47. 
Sceptical  reaction  against  theories  based  on  subjective 
valuations,  49.  Excessive  rationalism  of  time-preference 
theory,  51.  Time-preference  not  a  direct  determinant 
of  the  rate  of  interest,  53. 

CHAPTER  IV.     THE  ABSTINENCE  THEORY. 

The  abstinence  theory  treats  only  of  supply  of  capital 
and  does  not  give  a  complete  explanation  of  the  income 
of  capital,  55.  Accumulation  of  capital  without  subjective 
cost,  56.  Idea  of  marginal  savings,  57.  Ambiguities  of 
a  formulation  of  the  theory  in  terms  of  demand  and  supply, 
59.  The  two  fundamental  propositions  of  the  theory,  61. 
Criticism  of  idea  that  changes  in  supply  of  capital  regu- 
lative of  rate  of  return  are  brought  about  by  marginal 
savers,  62.  Prime  factors  determining  supply  of  capital 
are  objective,  not  subjective,  68.  Supply  of  capital,  on 
the  whole,  tends  to  rise  with  increase  in  rate  of  return,  70. 
Does  not  decrease  as  rate  of  return  declines,  71.  Factors 
which  prevent  extinction  of  capitalist  income,  73.  Only 
extreme  changes  in  rate  of  interest  affect  determination 
to  save,  75.  Theory  of-  rate  of  capitalist  income  must 
emphasize  objective  factors,  77.  Does  abstinence  theory 
explain  existence  of  interest?  79. 

CHAPTER  V.     THE  PRODUCTIVITY  THEORY  OF  INTEREST. 

The  specific  productivity  theory,  82.  Difficulties  of 
imputing  a  specific  product  to  capital,  82.  Vicious  circle 
in  deriving  value  of  capital  goods,  85.  Productivity  theory 
does  not  show  how  interest  on  sums  spent  for  wages  is 
derived,  87.  Difficulties  growing  out  of  concept  of  capital 

II 


TABLE  OF  CONTENTS 

and  restricted  view  of  productive  process,  87.  A  form  of 
productivity  theory  suggested  by  Bohm-Bawerk  and 
Landry,  92.  The  assumption  of  a  normal  lack  of  capital 
made  by  this  theory,  94.  The  theory  at  bottom  almost 
the  same  as  the  specific  productivity  theory  and  encounters 
similar  difficulties  in  determining  value  of  capital  invested, 
95.  Importance  of  the  theory,  97. 

CHAPTER  VI.     THE  ESSENTIALS  OF  A  THEORY  OF  PROFIT  AND 

INTEREST. 

Relation  of  four  quantities  (gross  income,  net  income, 
rate,  and  capital)  expressed  in  two  equations,  99.  None 
of  theories  so  far  examined  has  explained,  or  is  justified 
in  assuming  as  accounted  for,  more  than  one  quantity,  100. 
Necessity  of  accounting  for  value  of 'capital  independently 
of  amount  of  product  or  rate  of  profit,  101.  Capital  consists 
of  wages,  and  profit  of  capital  is  a  residual  income,  102. 
Name  to  be  given  to  our  theory,  105.  What  prevents  fall 
of  prices  from  extinguishing  share  going  to  capital?  108. 
What  keeps  labor  from  getting  entire  marginal  product 
of  industry?  109.  How  is  surplus  value  growing  out  of  a 
series  of  processes  controlled  by  different  entrepreneurs 
distributed  at  a  uniform  rate  to  every  part  of  investment 
made  by  each  entrepreneur?  no.  Theory  here  proposed 
assumes  as  given  factors  transmitted  from  pre-capitalistic 
times,  112. 

CHAPTER   VII.     THE    THEORY   OF   WAGES.     THE   SUPPLY   OF 
LABOR. 

Relation  of  theory  of  wages  to  theory  of  income  of 
capitalist.  114.  Wage  theories  which  might  form  basis  of  a 
residual  claimant  theory  of  profit  and  interest,  115.  Mal- 
thusian  basis  of  subsistence  theory,  116.  Relation  between 
standards  of  living  and  wages,  117.  Arbitrary  character 
of  assumption  of  a  natural  wage,  118.  Marx's  criticism 
of  subsistence  theory,  119.  Immigration  a  disturbing 
factor,  119.  Need  of  a  theory  of  demand  for  labor  felt 
by  classical  economists,  120.  Rise  of  standard  of  living 
of  wage-earners  and  its  bearing  on  subsistence  theory  of 

III 


TABLE  OF  CONTENTS 

wages,  121.  Conditions  under  which  subsistence  theory 
has  some  validity,  122.  How  supply  price  of  labor  is 
determined,  124.  Why  geographical  differences  in  wages 
correspond  to  differences  in  productivity,  126. 

CHAPTER  VIII.     THE  THEORY  OF  WAGES.     THE  DEMAND  FOR 
LABOR. 
The  wages  fund  doctrine  suggests  a  collective  exchange, 

128.  Necessity  of  laborer  and  employer  coming  to  terms, 

129.  Does  possibility  of  substituting  machines  for  labor 
show  that  there  is  no  definite  wages  fund?    130.     Under 
static  conditions  and  when  production  period  of  maximum 
efficiency  has  been  reached,  there  is  a  definite  wages  fund, 
133.     Bohm-Bawerk's  wages  fund  theory,   135.     Is  wages 
fund  capable  of  quick  expansion?  137.     When  viewed  as  a 
money  fund,    138.      When  regarded  as  real  income,    139. 
The  bargain  theory  of  wages,   141.      Wages  fund  theory 
only  possible  explanation  of  general  level  of  wages,  142. 

CRITICISM  OF  PRODUCTIVITY  THEORY  OF  WAGES  — 
Erroneous  assumption  in  regard  to  expansibility  of  demand 
for  labor,  144.  Productivity  explains  comparative  wages 
only,  146.  Can  wages  be  paid  out  of  current  product?  149. 
Productivity  determines  wages  only  by  its  influence  on 
the  accumulation  of  capital,  151.  Wages  not  determined 
by  discounted  product  of  labor  because  there  is  no  rate 
of  discount  established  independently  of  level  of  wages,  153. 
Criticism  of  productivity  theory  on  ground  that  specific 
product  of  labor  is  not  ascertainable,  155. 

CONCLUSION  —  General  level  of  wages  is  determined  by 
size  of  wages  fund  and  the  supply  price  of  different  quan- 
tities of  labor,  157. 

CHAPTER  IX.     CONCLUSION. 

The  two  stages  in  our  analysis  of  the  problem  of  dis- 
tribution, 159.  Criticism  of  the  concept  of  capital  as 
including  land,  160.  Criticism  of  the  "law  of  three  rents," 
1 60.  Summary  of  conclusions  reached,  163.  The  return 
to  the  classical  school  of  economists,  164.  Unfortunate 
tendencies  of  modern  economic  theorizing:  (i)  Excessive 
rationalism,  166.  (2)  Confusion  of  problem  of  distri- 
bution with  that  of  value,  167. 

IV 


PROFIT  AND  WAGES 

CHAPTER  I 

INTRODUCTION 

In  the  meaning  usual  to  economic  literature, 
distribution  is  division  into  parts  and  the  appor- 
tionment of  the  parts  to  those  who  share  in 
the  division.  Now  it  is  the  distribution  of  in- 
come rather  than  of  wealth  with  which  we  are 
here  concerned.  Income  is  wealth  just  pro- 
duced or  come  into  existence.  It  should  be 
thought  of  as  a  stream  and  measured  by  its 
volume  per  unit  of  time.  Taking  the  collective 
view  essential  to  the  science  of  economics 
the  problem  becomes  that  of  the  division  of 
the  total  income  or  produce  of  human  industry. 
We  are  to  explain  how  the  flow  of  goods  from 
mine  and  farm  and  factory  spreads  and  divides 
into  streams  of  private  income,  —  into  the 
rent,  profit,  and  interest,  for  instance,  which 
fall  to  the  well-to-do,  or  the  wages  with  which 
the  poor  must  be  content. 

As  the  ultimate  significance  of  these  streams 
of  goods  is  in  the  uses  made  of  them,  one  might 
regard  income  as  consisting  of  the  feelings  of 
the  consumer  of  goods  rather  than  of  the  goods 
themselves.  But  such  a  conception  of  income 
would  not  serve  the  purposes  of  the  present 
inquiry.  "Psychic  income"  is  too  remote  from 


2  PROFIT  AND  WAGES 

the  problems  with  which  a  study  of  distribution 
must  begin.  The  amount  of  utility  derived 
from  equal  quantities  of  any  commodity  varies 
widely  as  between  different  consumers  and 
even  between  different  times  and  conditions 
for  the  same  consumer.  The  final  determina- 
tion of  psychic  incomes,  therefore,  lies  in  the 
process  of  consumption.  It  comes  at  a  later 
stage  than  that  of  distribution.* 

Income  is  measurable  only  as  a  rate,  as 
amount  per  unit  of  time.  The  total  of  wealth, 
on  the  other  hand,  cannot  be  measured  otherwise 
than  by  taking  the  quantity  existing  at  a  point 
of  time.  As  such  it  would  include  the  income 
of  the  moment  but  also  the  wealth  which  has 
arisen  or  come  in  at  previous  times  and  which 
still  remains  unconsumed  and  undestroyed. 
When  referring  to  income,  the  term  distribution 
evidently  denotes  a  process.  When  applied 
to  wealth,  however,  it  means  the  result  or  out- 
come of  a  process  of  distribution,  or  of  a  series 
of  such  processes.  The  method  of  investigation 
must  differ  according  as  the  object  of  inquiry 
is  the  process  or  the  result.  To  picture  the 
result,  the  distribution  of  wealth  at  any  point 
of  time,  the  only  satisfactory  method  would  be 
the  statistical.  If  complete  date,  were  available, 
the  statistician  could  tell  us  how  many  rich 
men  there  are  and  what  is  their  wealth,  and  how 

*A  very  satisfactory  discussion  of  income  thought  of  as  a  stream 
of  goods  can  be  found  in  Lexis,  Allgememe  Volkswirtschafts- 
lehre,  p.  137  ff. 


INTRODUCTION  3 

many  poor  there  are  and  what  is  the  depth  of 
their  poverty.  The  explanation  of  how  this 
distribution  came  about  would  constitute  an 
historical  problem.  It  is  not,  however,  the 
object  of  the  present  essay  to  describe  and 
explain  the  distribution  of  an  existing  stock  of 
wealth.  Our  problem  is  the  complicated  process 
of  parcelling  out  the  newly  produced  wealth  or 
income  of  society.  In  the  analysis  of  such  a 
process  statistics  and  history  can  give  little 
aid.  At  least  in  the  initial,  and  most  difficult 
stages,  of  the  inquiry,  the  method  of  "theory" 
alone  is  of  service. 

This  is  the  method  of  mental  experiment 
with  different  lines  of  approach  to  the  problem,— 
the  exploitation  of  different  facts  and  ideas  as 
tentative  premises.  The  forces  of  our  indus- 
trial system  are  so  involved  that  no  conception 
of  its  operation  could  be  reached  by  any  attempt 
to  describe  its  details.  In  fact  the  more  photo- 
graphic and  concrete  the  picture  presented  to 
the  mind,  the  more  confusing  and  difficult 
the  problem  becomes.  The  only  feasible  pro- 
cedure, therefore,  is  to  seek  for  essential  facts 
and  to  reason  from  these,  while  deliberately 
excluding  from  view  a  mass  of  complicating 
phenomena.  Intellectually  portable  and  man- 
ageable results  are  won  by  selection  only.  Com- 
plications must  be  eliminated,  or,  in  other 
words,  hypothetical  assumptions  must  be  made. 
Economic  theory  differs  from  other  sciences 
only  in  the  degree  of  its  hypothetical  character. 


4  PROFIT  AND  WAGES 

But  for  use  in  practical  affairs,  or  to  satisfy  a 
mental  craving  for  a  more  concrete  picture  of 
the  world,  our  first  simplified,  hypothetical, 
general  theory  may  be  subjected  to  a  series  of 
qualifications  by  bringing  in  one  by  one  the 
complicating  conditions  which  had  been  ex- 
cluded at  the  beginning.  Thus  a  series  of  prop- 
ositions may  be  reached  which,  descending 
into  ever  greater  detail,  lead  us  by  successive 
approximations*  to  a  closer  view  of  things  as 
they  are.  How  closely  we  desire  to  approxi- 
mate the  confusing  reality  of  our  industrial 
life,  or  at  the  other  extreme,  how  far  we  are 
willing  to  carry  the  process  of  abstraction  to 
gain  a  general  view,  depends  largely  on  our 
mental  constitution.  It  is  not  altogether  flippant 
to  call  it  a  matter  of  taste.  In  the  end,  however, 
the  use  we  intend  to  make  of  our  theories  may 
decide  to  what  degree  of  abstraction  from  or 
approximation  to  the  complexities  of  the  actual 
world  we  may  safely  proceed. 

"The  idea  of  "successive  approximations,"  a  metaphor  derived 
from  physics  and  mathematics,  has  perhaps  received  its  vogue 
especially  from  Pareto  (Cours  d'economie  politique,  p.  16  ff.). 
Graziani  (Instituzioni  di  economia  politico,,  p.  45)  attributes 
the  use  of  the  term  especially  to  Pareto  and  Barone  but  says 
that  the  method  itself  goes  back  to  the  classical  writers  such 
as  Smith,  Ricardo,  and  the  two  Mills.  It  has  probably  been 
used  more  or  less  deliberately  by  many  writers.  The  opening 
paragraph  of  the  third  volume  of  Das  Kapital,  for  instance, 
shows  Marx  making  conscious  use  of  this  method.  The  mention 
of  Marx  suggests  the  dangers  and  difficulties  of  beginning 
with  assumptions  too  remote  from  reality.  A  recent  instance 
of  a  start  too  remote  from  reality,  in  the  present  writer's  opinion, 
is  that  made  by  Schumpeter  (Theorie  der  wirtschaftlichen 
Entwicklung) . 


INTRODUCTION  5 

It  follows  from  what  has  just  been  said  that 
the  general  theory  of  the  distribution  of  income 
aimed  at  in  the  following  pages  must  submit  to 
certain  limitations.  To  state  some  of  these, 

(1)  it  must  confine  itself  to  what  may  be  called 
the  primary  process  of  distribution,  the  dividing 
up  of  the  product  of  industry  among  the  parties 
immediately    connected    with    the    productive 
process.     In  other  words,  our  problem  is  that 
of    wages,    interest,    profit,    and    rent.      How 
secondary  incomes  are  derived  from  these  pri- 
mary  shares    through   gift,    theft,    begging    or 
taxation,  need  not  concern  us.    Profits  or  other 
incomes   from   business   operations   which   are 
not  productive  or  whose  relation  to  production 
is  remote  and  uncertain,  must  also  be  omitted 
from  consideration.     Various  "pecuniary"  em- 
ployments   of    capital,    as    Veblen   would    call 
them,  —  speculative  manipulations,  for  instance, 

-  for  all  their  spectacular  interest  and  dis- 
turbing significance,  must  be  excluded.  To  get 
a  clear  view  of  the  fundamental  factors,  our 
study  must  stick  closely  to  the  process  of 
production  and  to  those  classes  which  draw 
their  living  immediately  from  that  process. 

(2)  Our   study  must  assume  the  prevalence  of 
competition.     At  a  time  of  widespread  appre- 
hension of  the  growing  power  of  large  aggre- 
gations of  capital,  this  assumption  may  appear 
to  lead  to  conclusions  somewhat  too  remotely 
connected  with  contemporary  conditions.    How- 
ever the  extent  of  the  monopoly  exercised  by  those 


6  PROFIT  AND  WAGES 

to  whom  popular  opinion  attributes  this  power, 
is  somewhat  in  doubt  and  certainly  their 
power  is  not  absolute.  The  mixture  of  com- 
petition and  monopoly  in  the  industrial  life  of 
today  cannot  be  understood  unless  we  have  a 
clear  conception  of  the  workings  of  a  competitive 
system.  For  the  purposes  of  our  theory  it  will 
be  well,  therefore,  to  set  aside  monopoly  as  a 
disturbing  factor  acting  upon  a  fundamentally 
competitive  order.  In  other  words  we  reach  a 
"first  approximation"  by  assuming  a  competitive 
system.  (3)  Another  limitation  to  which  our 
theorizing  must  submit  is  in  the  historical 
range  of  its  application.  It  is  confined  to 
present  conditions,  to  the  "system  of  industrial 
liberty,"  to  "capitalism."  Starting  from  facts 
and  conditions  of  the  present,  it  may  not  assume 
universal  validity  for  its  conclusions.  On  the 
other  hand  it  is  under  no  necessity  of  accounting 
for  the  origin  and  evolution  of  economic  insti- 
tutions which  our  industrial  system  has  inherited 
from  the  past.  It  may  take  their  existence  for 
granted,  asking  only  how  they  affect  the  quantity 
of  income  going  to  the  different  "shares  in 
distribution." 

The  foregoing  limitations  are  observed 
throughout  this  book.  Other  assumptions  will 
be  made  from  time  to  time  to  save  the  argu- 
ment from  unnecessary  complication.  Although 
these  are  not  always  explicitly  mentioned,  we 
trust  they  will  be  reasonably  obvious  to  the 
reader  and  will  be  such  as  experience  has  shown 


INTRODUCTION  7 

to  be  necessary  to  the  operations  of  economic 
theory.  The  results  reached  by  the  method 
pursued  are  necessarily  propositions  of  an 
abstract  character.  To  the  type  of  mind  that 
hungers  for  graphic  and  abundant  detail  they 
may  appear  very  unsatisfactory.  But  our 
present  aim  is  an  analysis  of  the  industrial 
world,  not  photography,  and  so  no  other  course 
lies  open. 

To  find  the  starting  points  for  an  analysis 
of  the  distributive  process  it  will  be  prudent  to 
examine  the  results  of  the  mental  experimen- 
tation of  leading  thinkers  in  this  field.  The 
stock  of  facts  and  ideas  with  which  theory 
operates  is  selected  from  a  complex  reality 
largely  in  the  form  of  general  impressions  of 
what  may  prove  significant.  A  review  of  the 
impressions  of  able  theorists  as  to  what  elements 
enter  into  the  determination  of  the  shares  in 
distribution,  and  of  the  failures  and  successes 
of  the  different  theories  set  forth,  is  the  only 
sure  precaution  against  making  a  false  start. 
Our  work  then  must  be  largely  critical.  That 
to  save  time  the  discussion  is  restricted  to 
theories  which  still  have  some  standing  in 
scientific  controversy  will,  we  trust,  commend 
itself  to  the  approval  of  those  competent  in 
economic  studies.  But  before  entering  into 
the  necessarily  technical,  and  perhaps  confusing, 
detail  of  a  critical  study,  it  may  be  well  for  the 
sake  of  perspective  to  offer  the  reader  a  general 


8  PROFIT  AND  WAGES 

sketch  of  the  field  we  are  to  enter.    This  is  the 
purpose  of  the  remaining  pages  of  this  chapter. 

The  classical  economists  represented  the 
national  product  as  divided  among  landowners, 
capitalists,  and  laborers  —  three  rather  distinct 
classes  in  the  social  life  of  the  England  of  their 
day.  A  fortunate  tradition  for  the  theory  of 
1  distribution  was  thus  established  by  an  historical 
accident  of  time  and  place.  Had  the  owners  of 
capital  and  those  of  land  been  merged  as  com- 
pletely as  they  were  in  some  countries  and  as 
they  are  in  the  England  of  the  present  time, 
economic  theorists  might  have  failed  to  isolate 
the  share  in  distribution  that  falls  to  the  land- 
owner as  such.  A  part,  at  least,  of  what  goes 
under  the  popular  term  of  rent  of  land,  has 
important  characteristics  which  distinguish  it 
from  the  income  of  capital.  As  will  soon  appear, 
it  is  a  differential  gain  of  a  rather  permanent 
character.  Not  to  recognize  this  would  seriously 
distort  our  picture  of  the  distributive  process. 
In  the  writer's  opinion,  it  was  fortunate  also 
that  economists  did  not  at  once  make  and 
emphasize  the  distinction  between  capitalist 
and  entrepreneur,  which  later  came  into  fashion. 
The  capitalist  is  lender  and  investor  only  of 
capital,  the  entrepreneur  user  of  it.  To  an 
increasing  degree  the  entrepreneur  is  coming 
to  be  not  an  individual,  but  a  group  of  men, 
a  corporation.  It  will  be  convenient,  however, 
throughout  most  of  our  discussion  to  think  of 


INTRODUCTION  9 

him  as  an  individual  business  manager.  So 
conceived,  he  is  the  one  controlling  and  directing 
the  process  of  the  production  of  wealth.  The 
products  are  his  until  he  sells  them.  If  they  are 
unsaleable,  the  loss  is  his.  He  may  be  capitalist 
and  landowner  besides  being  entrepreneur.  In- 
deed, he  usually  owns  some  capital.  Out  of 
the  process  of  buying,  borrowing,  and  hiring 
for  his  business,  and  the  sale  of  the  products, 
he  gets  his  profit.  To  the  landowner  he  pays 
rent,  to  the  capitalist  interest,  to  the  laborer 
wages.  The  problem  for  the  theory  of  distribu- 
tion is,  what  determines  the  amount  of  each 
of  these  shares  in  distribution  —  rent,  interest, 
wages,  and  the  entrepreneur's  profit. 

Confusion  enters  into  this  controversial 
matter  at  the  very  outset,  through  the  failure 
to  agree  upon  some  distinct  concept  of  capital. 
What  is  this  thing  whose  ownership  gives  the 
power  to  get  an  income  without  labor,  or  in 
other  words,  to  levy  on  the  labor  of  others? 
Popular  terminology  is  indefinite  and  shifting. 
One  meaning  suggested  by  it,  that  of  capital 
as  a  sum  of  money  is  obviously  inadequate  for 
our  inquiry.  Even  if  it  were  permissible  either 
to  overlook  bank  credit  or  to  regard  it  as  a 
kind  of  money,  this  popular  concept  would  be 
too  superficial.  It  is  what  is  bought  with  the 
money  by  the  managers  of  productive  enter- 
prises that  makes  it  effective  in  securing  an 
income  and,  which,  therefore,  constitutes  the 
true  capital.  It  will  be  advantageous  at  least 


io  PROFIT  AND  WAGES 

in  our  first  approximate  formulation  of  the 
theory  of  distribution,  to  forget  the  existence  of 
money  and  to  think  of  commodities  and  services 
as  exchanged  by  barter,  though  with  a  celerity 
and  ease  not  possible  to  that  crude  method  of 
exchange. 

Passing  from  popular  usage  to  that  of  the 
more  scientific  literature  of  economics,  we  meet 
a  discouraging  diversity  of  opinion.  In  general, 
however,  there  are  two  tendencies.  One  is 
to  regard  capital  as  a  sum  of  value,  the  other 
as  consisting  of  concrete  goods  of  some  kind. 
To  consider  capital  as  value  (or  as  a  sum  of 
prices)  instead  of  using  value  or  price  merely 
to  measure  a  quantum  of  capital,  gives  a  con- 
cept useful  only  to  one  theory  of  interest,  the 
time-preference  theory,  and  not  acceptable, 
therefore,  unless  that  theory  can  be  accepted.* 
Of  course  the  concept  is  also  useful  to  the  book- 
keeping or  accounting  of  private  and  individual 
economics  (Privatwirtschaft).  Our  aim,  how- 
ever, is  not  to  describe  the  individual's  method 
of  measuring  his  gains,  but  to  explain  the 
source  and  amount  of  income  that  goes  to  the 
owners  of  capital  as  a  class. 

*Professor  Clark  employs  a  concept  of  this  kind  in  connection 
with  a  productivity  theory.  Obviously,  however,  it  is  the 
concrete  "capital  goods,"  which  he  distinguishes  from  the 
fund  of  capital  or  capital  proper,  which  really  aid  production 
and  constitute  the  basis  of  the  capitalist's  income,  not  the 
abstract  fund  or  collective  value  of  these  goods.  See  remarks 
by  Carver  in  Quarterly  Journal  of  Economics,  May,  1907. 
See  also  the  trenchant  criticism  by  Bohm-Bawerk  ibid., 
November,  1906,  and  February,  1907,  and  by  Veblen  ibid., 
February,  1908. 


INTRODUCTION  1 1 

Of  definitions  of  capital  as  concrete  goods 
there  is  a  considerable  variety  but  two  may  be 
taken  as  dividing  between  them  a  large  part 
of  the  usage  of  economic  literature  —  one,  that 
of  capital  as  consisting  of  "intermediate  goods" 
or  goods  produced  to  be  used  in  further  pro- 
duction; the  other,  as  subsistence  maintaining 
labor  in  the  long  process  of  production,  and 
advanced  to  the  laborers  out  of  past  product 
by  the  capitalist  class.  Which  of  these  is  to 
be  preferred  can  be  decided  only  when  we 
inquire  what  each  leads  to  when  used  as  a  basis 
for  a  theory  of  interest.  Some  reasons  will  be 
given  at  this  point  for  choosing  the  view  of 
capital  as  subsistence  advanced  to  the  laborers. 
The  chief  purpose  of  these  remarks,  however, 
is  not  to  dispose  definitively  of  the  question  of 
the  proper  definition  of  capital,  but  to  give  the 
reader  the  background  of  a  general  picture 
of  the  production  and  distribution  of  wealth. 

If  capitalists  as  a  class  enjoy  a  peculiar  income, 
that  income  must  in  some  way  be  traced  to 
the  peculiar  contribution  made  to  the  pro- 
ductive process  by  capitalists  as  a  class.  To 
this  contribution  it  would  seem  appropriate 
to  give  the  name  capital  if  that  trouble-breeding 
term  is  to  be  used  at  all.  *  Now  what  capitalists 

*Something  might  be  said  in  favor  of  dropping  the  term  alto- 
gether from  economic  theory  because  of  the  confusion  it  has 
always  caused.  The  dreary  debate  about  its  proper  meaning 
has  had  the  advantage  of  establishing  in  our  terminology  a 
number  of  convenient  names  for  proposed  claimants  for  the 
title  of  capital,  e.  g.,  intermediate  goods,  producers'  goods, 


12  PROFIT  AND  WAGES 

as  a  class  contribute  is  the  subsistence  of  the 
laborer  or  wages  (that  is  real  wages).  This 
appears  when  we  consider  the  entire  process  of 
the  production  of  any  consumable  commodity, 
viewing  it  as  beginning  with  the  first  labor 
employed  to  make  any  instrument  or  material 
used  in  the  course  of  the  long  process.  Pro- 
duction is  then  seen  to  be  simply  the  use  of 
labor  power  on  the  physical  world.  The  process 
of  making  any  commodity  may  be,  and  usually 
is,  divided  into  different  stages,  controlled  by 
different  entrepreneurs.  The  latter  contribute 
the  labor  of  scheming  and  directing,  but  the 
capitalists,  or  the  entrepreneurs  in  so  far  as 
they  are  capitalists,  contribute  nothing  but  the 
wages  paid  to  the  laborers.*  This  is  the  one 
investment  of  capitalists  as  a  class  with  reference 
to  productive  enterprise.  The  "capital  goods" 
such  as  machines,  raw  material,  etc.,  which 
appear  in  the  productive  process,  are  bought 
by  one  capitalist  or  entrepreneur  from  another. 
The  purchase  and  sale  of  these  products  or 
intermediate  goods,  however,  is  a  purely  intra- 
class  affair.  Such  purchases  and  sales  are  a 

consumers'  goods,  durable  goods.  The  use  of  these  terms  in 
place  of  the  ambiguous  word  capital  would  clarify  many 
economic  discussions. 

"Our  reason  for  not  mentioning  the  rent  of  land  among  the 
payments  made  by  the  capitalist  will  soon  appear  (page  15  ff.). 
Taxes  may  also  be  disregarded.  We  may  think  of  them  as 
paid  out  of  income  and,  in  any  case,  as  having  no  necessary 
direct  relation  to  the  process  of  producing  and  distributing 
wealth. 


INTRODUCTION  13 

means  of  dividing  up  between  different  capital- 
ists the  capital  investment  necessary  in  the 
long  process  of  producing  any  consumable 
commodity.  The  buyer  of  a  machine  for 
instance,  pays  the  seller  the  wages  the  latter 
had  paid  in  having  the  machine  made.  As  the 
price  of  the  machine,  however,  also  includes 
interest  and  profit  to  the  seller,  the  purchase 
and  sale  of  such  "intermediate  goods"  also 
appears  as  means  of  dividing  up  the  profits 
and  gains  of  capital  of  the  entire  productive 
process.  But  these  transactions  within  the 
class  of  capital  owners  constitute  no  part  of 
the  necessary  contribution  of  the  capitalist 
class  to  the  process  of  production.  The  necessary 
contribution  of  this  class,  the  investment  from 
which  it  derives  its  income,  the  mysterious 
thing  called  capital,  consists  of  the  subsistence 
or  "real  wages"  given  the  laborer.  For  the 
theory  of  distribution  at  least,  this  seems  the 
most  fruitful  conception  of  capital. 

And  now  we  return  to  the  question  asked  a 
few  pages  back  as  to  what  determines  the  amount 
of  each  share  in  distribution  —  of  rent,  interest, 
profit,  and  wages.  In  the  attempt  to  give  a 
preliminary  sketch  of  the  questions  at  issue, 
we  may  start  with  an  idea  which  has  come 
very  near  to  having  gained  universal  acceptance 
among  economists,  and  make  it  the  background 
for  a  formulation  of  the  principal  contending 
theories.  This  idea  is  that  of  a  distinction 
between  differential  and  marginal  income.  The 


i4  PROFIT  AND  WAGES 

productive  result  of  the  investments  made  by 
capitalists  and  entrepreneurs  varies  widely. 
Any  return  in  excess  of  the  lowest  or  marginal 
rate  of  productivity  is  a  differential  gain,  and 
may  take  the  form  either  of  rent  of  land,  or 
of  differential  profit.  The  most  permanent 
differences  in  productivity  are  inherent  in  the 
quality  and  location  of  the  land  which  is  used. 
Less  stable  differences  may  be  traced  to  the 
differing  abilities  and  luck  of  the  entrepreneurs. 
As  the  capital  of  the  world  increases,  entre- 
preneurs proceed  to  less  and  less  productive 
investments  —  assuming  that  they  first  took 
advantage  of  the  best  opportunities.  The 
course  of  investment  is  from  more  to  less 
productive  lands  and  locations,  stopping  at 
successive  "extensive  margins,"  and  also  from 
more  to  less  productive  investments  on  the 
same  land,  according  to  the  "law  of  diminishing 
returns,"  making  successive  stops  at  "intensive 
margins."*  On  the  assumption  of  perfect 
mobility  of  capital,  a  given  total  of  capital 
will  be  so  distributed  in  its  investment  as  to 
establish  a  uniformly  productive  margin  along 

*The  law  of  diminishing  returns  from  land  will  hold,  that  is 
there  will  be  an  increase  of  total  product  but  a  dirriinished 
product  per  unit  of  investment,  if  the  additional  "capital" 
invested  takes  the  form  of,  or  results  in,  an  increased  appli- 
cation of  either  labor  or  capital  goods  to  the  land.  As  will 
appear  later,  it  is  possible  that  an  increased  supply  of  capital 
may  bring  about  nothing  but  an  increase  in  the  rate  of  wages. 
In  that  case,  of  course,  there  is  no  increase  of  total  or  decrease 
of  marginal  product.  The  relative  shares  received  by  capital 
and  labor  will  be  changed,  but  there  will  be  no  change  in  the 
differential  gains. 


INTRODUCTION  15 

both  the  extensive  and  intensive  frontier.  Addi- 
tions to  the  supply  of  capital  can  then  be  invested 
at  the  margin  only,  and  get  only  the  marginal 
rate  of  return  —  unless  they  can  displace  capital 
at  other  points.  The  competition  of  this  new 
capital  with  the  older  supplies  which  it  is 
capable  of  displacing,  tends  to  make  the  marginal 
rate  the  rate  of  return  for  all  capital,  by  giving 
the  landowner  the  power  to  demand  all  in 
excess  of  this  (except  the  " ability  rent"  of  the 
superior  entrepreneur)  as  a  rent.*  At  the 
outset,  of  course,  the  entrepreneur  receives  the 
entire  product,  but  the  destination  of  all  the 
differential  gain,  the  surplus  over  the  marginal 
rate  of  return,  is  apparent. 

We  may  thus  view  the  problem  of  distribution 
as  being,  at  the  first  stage,  a  question  between 

*The  rate  of  "productivity"  of  capital  at  the  margin  would 
vary  accordingly  to  the  ability  of  the  entrepreneurs  managing 
it.  A  marginal  rate,  therefore,  if  it  is  to  be  something  definite, 
implies  a  marginal  managerial  ability.  The  amount  of  capital 
(and  consequent  size  of  business)  controlled  by  different 
entrepreneurs  tends  to  vary  according  to  their  ability  and 
energy,  the  least  competent  of  the  entrepreneurs  able  to 
maintain  themselves  against  competition,  the  marginal  entre- 
preneurs, controlling  the  smallest  business  units.  This  on 
the  assumption,  very  far  indeed  from  being  fully  justified  by 
the  reality,  that  the  control  of  capital  is  distributed  according 
to  ability  and  not  by  accident  and  favor.  Because  of  the 
advantages  of  large  scale  production,  those  able  to  manage 
large  amounts  of  capital  will  get  a  higher  rate  of  return  than 
the  marginal  entrepreneur,  a  differential  profit,  even  for  their 
marginal  investments.  The  marginal  rate  pays  only  interest 
and  "wages  of  management"  to  capitalist  and  entrepreneur, 
but  the  abler  entrepreneurs  get  more  than  this  rate.  Even 
under  static  conditions,  therefore,  there  is  a  differential  profit 
graded  roughly  according  to  the  ability  of  the  entrepreneur. 
Under  dynamic  conditions,  there  are  also  the  temporary  gains 
that  come  to  the  alert,  progressive,  and  lucky  ones. 


1 6  PROFIT  AND  WAGES 

entrepreneur  and  landowner.  Whatever  the 
productive  forces  applied  to  the  land,  they 
represent  capital  investment  to  the  entrepre- 
neur. When  they  yield  a  surplus  above  the 
marginal  rate,  this  becomes  either  the  rent 
of  the  landowner  or  the  differential  profit  of 
the  entrepreneur.  But  this  division  between 
differential  and  marginal  income  is  not  the 
whole  of  the  distribution  to  be  made.  The 
entrepreneur  has  also  to  deal  with  the  laborer 
and  the  question  then  becomes  that  of  dividing 
marginal  income,  the  product  remaining  after 
the  subtraction  of  the  differential  gains.  Here 
we  reach  the  questions  most  in  controversy. 
The  fact  of  differential  gains  is  pretty  well 
acknowledged,  however  much  economists  may 
disagree  in  regard  to  its  different  aspects. 
But  on  the  problem  of  the  division  of  the 
"marginal  product"  between  capitalist  and 
entrepreneur,  on  the  one  hand,  and  the  laborer, 
on  the  other,  there  are  the  most  persistent  and 
irreconcilable  differences  of  opinion.  A  dis- 
cussion of  the  theory  of  distribution  inevitably 
must  deal  chiefly  with  the  controversies  over 
the  character  of  the  apportionment  of  the 
marginal  product  between  capital  and  labor. 

A  diagram  may  be  used  to  show  the  relation 
between  differential  and  marginal  incomes.  Let 
the  figure  CAED  represent  the  total  product 
of  industry.  Distance  from  line  AE  measures 
productivity  and  distance  along  AE  the  quantity 
of  capital  invested.  DE  indicates  productivity 


INTRODUCTION 


at  the  margin,  and  CBD  the  total  of  differen- 
tial gains  (rent  and  differential  profit).  The 
controversial  problem  for  the  theory  of  distribu- 
tion is  that  of  accounting  for  the  division  of 
ABDE  between  labor  and  capital.* 


Holding  throughout  the  point  of  view  gained 
by  setting  aside  rent  and  some  profits  as  differ- 
ential and  concentrating  our  attention  on  the 
division  of  the  marginal  product  and  the  rates 

*The  diagram  is  constructed  with  reference  to  illustrating  the 
quantitative  aspects  of  the  division  of  the  total  product  rather 
than  the  source  of  each  share.  It  would  be  misleading  if  it 
suggested  that  labor  and  capital  get  their  return  from  the 
same  monthly  or  annual  product.  If  capital  gets  its  return 
from  current  product,  then  wages  must  be  thought  as  paid  out 
of  earlier  product.  The  rectangle  A  BDE  should  really  be 
interpreted  as  that  part  of  the  gross  income  of  the  entrepreneur 
left  after  deducting  rent  and  differential  profit,  and  the  portion 
marked  "return  to  labor"  as  the  equivalent  of  the  wages 
which  have  been  paid. 

For  the  sake  of  a  simplified  statement  no  mention  is  made 
above  of  non-differential  profits,  or  what  are  sometimes  regarded 
as  "wages  of  management."  Some  writers  would  merge 
them  with  the  return  to  capital  as  part  of  the  "profit  of  capital" 
( Kapitalgewinn) ;  others  would  merge  them  with  wages  as 
payment  for  labor.  Reasons  for  giving  our  preference  to  the 
former  alternative  will  appear  later. 


1 8  PROFIT  AND  WAGES 

of  interest  and  wages  thus  established,  we  may 
mention  briefly  some  of  the  principal  attempts 
to  explain  the  division  of  product  between 
capital  and  labor. 

One  method  of  explaining  the  existing  division 
of  ABDE  is  to  find  a  factor  determining  one  of 
the  two  shares  independently  of  the  other  and 
of  the  amount  to  be  divided.  This  leaves  the 
recipient  of  the  other  a  "residual  claimant." 
Ricardo,  for  instance,  describes  the  share  going 
to  labor  as  determined  by  the  cost  of  the  laborer's 
subsistence  according  to  some  more  or  less 
fixed  standard  of  living.  The  remainder  of 
the  marginal  product  would  then  constitute 
"profit  of  capital."  Or,  on  the  other  hand, 
wages  may  be  made  to  appear  a  residual  income 
by  representing  the  return  to  capital  as  deter- 
mined by  some  subjective  factor  such  as  cost 
of  abstinence  or  waiting,  or  by  the  degree  of 
preference  for  present  over  future  possession. 
A  favorite  variant  of  the  theory  appears  when 
wages  are  spoken  of  as  the  discounted  marginal 
product,  the  rate  of  discount  being  set  by 
the  "rate  of  time-preference." 

'  Another  method  of  explaining  the  division 
of  the  marginal  product  is  to  seek  for  an  inde- 
pendent explanation  for  each  of  the  two  shares. 
Thus  the  theory  of  specific  productivity  declares 
that  capital  and  labor  receive  each  its  specific 
product. 

Another   method   rests   on   a   denial   of   the 
possibility  of  an  independent  explanation  for 


INTRODUCTION  19 

either  share  and  declares  the  existing  division 
to  be  simply  the  outcome  of  a  struggle  between 
capital  and  labor.  This  is  the  view  suggested 
by  the  frequent  reference  of  German  writers 
to  Machtverhaltnisse,  to  relative  power,  as  deter- 
mining distribution,  and  by  the  somewhat  more 
definite  "bargain  theory"  of  wages  set  forth  by 
Davidson.* 

In  seeking  to  account  for  the  division  of 
product  between  capital  and  labor,  we  appear 
to  be  restricted  in  our  choice  to  one  of  the  three 
methods  just  indicated.  We  must  find  (i) 
an  independent  explanation  for  either  wages  or 
the  gains  of  capital,  in  which  case  we  may 
account  for  the  other  share  as  residual.  If  that 
cannot  be  done  we  must  either  find  (2)  an  inde- 
pendent explanation  for  wages  and  also  such  an 
explanation  for  interest,  or  (3)  we  must  regard 
the  division  of  product  between  capital  and 
labor  as  the  outcome  of  a  tug  of  war. 

*  The  Bargain   Theory  of  Wages. 


CHAPTER  II 
BOHM-BAWERK'S  THEORY  OF  INTEREST 

It  is  a  not  uncommon  practice  to  treat  of 
one  of  the  shares  in  distribution,  of  wages,  for 
instance,  or  interest,  or  rent,  without  showing 
its  relation  to  the  remaining  shares.  A  satis- 
factory theory  of  any  one,  however,  implies 
some  particular  view  in  regard  to  the  others. 
Every  consistent  thinker  on  these  subjects 
holds  a  definite  theory  of  distribution  as  a 
whole.  He  cannot  rest  satisfied  with  discon- 
nected theories  of  wages,  interest,  profit,  and 
rent.  But,  however  desirable  it  might  appear 
to  consider  theories  of  the  entire  process  of 
distribution,  rather  than  theories  of  particular 
incomes,  a  critical  study  such  as  has  been 
proposed  above,  must  accomodate  itself  to 
the  disjointed  character  of  economic  discussion. 
A  beginning  must  be  made  with  some  one  of 
the  so-called  shares,  and  for  various  reasons 
the  theory  of  interest  will  best  serve  as  an 
introduction  to  the  problem  before  us. 

Now  a  strategic  point  at  which  to  begin 
is  given  by  the  agio  theory  of  Bohm-Bawerk. 
It  is  a  highly  developed  and  individual  doctrine, 
based  on  a  searching  criticism  of  other  theories. 
Stated  with  great  clearness  and  amply  elabor- 
ated, it  is  free  from  the  obscurities  of  much 
of  the  older  speculation  on  this  subject.  It 


BOHM-BAWERK  S  THEORY  OF  INTEREST        21 

will  be  desirable,  therefore,  in  the  case  of  this 
eminent  writer  to  depart  from  the  rule,  adopted 
in  most  of  the  following  pages,  of  considering 
general  types  and  schools  of  thought  rather 
than  the  formulations  of  particular  theorists. 

The  fundamental  concept  of  Bohm-Bawerk's 
theory  is  a  preference  for  present  goods  over  an 
equal  quantity  of  future  goods  of  the  same  kind. 
Because  of  this  preference,  he  holds,  interest 
is  paid  as  a  premium  for  present  goods  given 
in  exchange  for  future  goods;  or  expressed 
differently,  interest  is  a  discount  to  which 
future  goods  are  subject  when  exchanged  for 
present.  Now  undoubtedly  a  preference  of 
this  kind  exists,  and  may  manifest  itself  when 
there  is  occasion  for  comparing  present  and 
future  sums  of  money,  or  commodities  readily 
exchanged  for  money.  This  preference,  however, 
is  obviously  due,  in  large  part,  if  not  wholly, 
to  the  possibility  of  obtaining  interest  from  the 
investment  of  money.  It  is  a  result  of  the 
existence  of  the  institution  of  interest  rather 
than  a  possible  factor  in  bringing  about  its 
existence.  The  problem  raised  by  Bohm- 
Bawerk's  theory  therefore  becomes  the  highly 
hypothetical  one  of  whether,  if  there  were  no 
interest  payment  to  be  expected  —  if,  for 
instance,  interest  were  prohibited  and  the  pro- 
hibition enforced,  —  there  would  still  be  a 
preference  for  present  goods,  (or  money  as  a 
means  of  purchasing  goods)  over  future  goods 
(or  money).  And  Bohm-Bawerk  adds  to  the 


22  PROFIT  AND  WAGES 

hypothetical  character  of  the  problem  by  elimi- 
nating the  effect  of  any  uncertainty  in  regard 
to  future  goods,  such  uncertainty  not  being 
necessary  to  a  preference  for  present  goods 
though  adding  to  the  discount  of  future  goods.* 
If  a  preference  for  present  over  future  possession, 
existing  independently  of  the  possibility  of 
obtaining  interest  and  not  arising  from  any 
uncertainty  or  risk  attaching  to  the  future 
goods,  could  be  proved,  this  preference  being 
felt  by  a  considerable  number  of  persons  and 
to  a  degree  sufficient  to  be  of  significance  and 
to  lend  probability  to  a  theory  based  upon  it, 
then  Bohm-Bawerk's  theory  would  not,  indeed, 
be  fully  established,  but  would  have  a  clear 
title  to  further  consideration.  For  a  complete 
demonstration  of  the  truth  of  the  theory,  it 
would  be  necessary  to  show  that  such  a  prefer- 
ence for  present  goods  could  and  does  alone 
account  both  for  the  existence  of  interest  and 
its  amount.** 

As  proof  of  the  existence  and  operation  of 
the  preference  for  present  goods  to  which  he 
attributes  the  appearance  of  interest  on  capital, 
Bohm-Bawerk  gives  three  "causes"  of  such 

""I  repeat  that  the  element  of  uncertainty,  which  is  the  cause 
of  a  lesser  value  being  put  upon  particular  classes  of  future 
goods,  has  no  causal  connection  with  the  phenomenon  of 
interest.  The  lesser  valuation  which  is  its  effect  is  a  special 
one,  and  extends  to  one  class  of  future  goods  only,  and  there 
it  bears'  the  character  of  a  deduction  as  premium  for  risk." 
Positive  Theory  of  Capital,  p.  247. 

**Except  in  so  far  as  the  amount  is  affected  by  the  element  of  risk. 


BOHM-BAWERK'S  THEORY  OF  INTEREST      23 

preference:  (i)  differences  in  relative  pro- 
vision for  present  and  future  wants,  typical 
cases  being  that  of  immediate  distress  and  that 
of  prospects  of  increased  wealth  in  the  future, 

(2)  the   underestimate   of   future   advantages 
and  future  goods  due  to  want  of  imagination, 
defect  in  will,  and  the  uncertainty  of  life,  and 

(3)  the  "technical  superiority"  of  present  goods. 
The  third  of  these  causes  of  preference,  being 

based  on  a  technical  fact  in  the  field  of  pro- 
duction, is  evidently  of  a  different  nature  from 
the  other  two.  It  is  also  the  one  which  has 
been  most  called  into  question,  and,  therefore, 
may  properly  be  the  first  to  be  subjected  to 
a  critical  examination.  The  "technical  superi- 
ority of  present  goods,"  according  to  Bohm- 
Bawerk,  rests  on  the  greater  productivity  of  a 
long  process  of  production  compared  with  any 
shorter  process  using  the  same  quantum  of 
productive  powers.  In  this  statement  the 
process  of  production  of  any  commodity  must 
be  understood  as  including  not  only  every  step 
in  making  and  marketing  the  commodity  in 
question,  but  all  preliminary  steps,  such  as 
extracting  and  refining  the  raw  material,  making 
and  transporting  necessary  instruments  of  pro- 
duction, et  cetera.  The  longer  process,  therefore, 
is  the  one  with  the  relatively  larger  amount  of 
the  results  of  previous  labor  employed  in  the 
later  stages.  In  the  older  and  more  familiar 
phrase,  it  is  the  one  with  the  larger  "investment 


24  PROFIT  AND  WAGES 

of  capital."*  The  proposition  that  an  extension 
of  the  process  of  production  over  a  longer 
period  results  in  an  increase  of  product  per 
unit  of  investment,  is  at  bottom  only  the 
familiar  assertion  of  the  productive  advantage 
of  increasing  capital  equipment.  Bohm- 
Bawerk's  novel  formulation  of  this,  however, 
led  to  some  controversy.  In  his  Strittige  Fragen 
and  in  the  third  edition  of  the  Positive  Theorie 
des  Kapitales,  he  has  no  difficulty  in  disposing 
of  most  of  the  objections  made  to  the  proposi- 
tion in  question.  However,  it  appears  that  a 
continued  lengthening  of  the  production  period, 
beyond  a  certain  point,  results,  not  in  an  increas- 
ing, but  in  a  decreasing  rate  of  return.**  With 

"The  amount  of  capital  invested  does  not,  however,  vary 
exactly  with  the  length  of  the  productive  process.  See  third 
edition  of  the  Positive  Theorie  des  Kapitales  (Exkurs  V). 

**To  measure  the  length  of  the  production  period  of  any  com- 
modity, we  must  take,  according  to  Bohm-Bawerk  (Positive 
Theory,  page  88),  not  the  "absolute"  duration,  the  time  elapsing 
between  the  first  step  in  the  process  and  the  last,  but  its  average. 
The  latter  is  calculated  by  first  multiplying  each  productive 
unit  invested  (of  labor  and  of  "uses  of  land")  by  the  number 
of  years  from  the  time  of  investment  to  the  completion  of  the 
consumable  commodity,  then  adding  together  these  arith- 
metical products  and  dividing  by  the  number  of  units  invested. 
Bohm-Bawerk,  in  his  explanation,  leaves  out  "for  the  sake  of 
simplification,"  the  co-operating  "uses  of  land."  In  this  we 
may  follow  him  with  a  clear  conscience  if  we  reflect  that,  on 
the  margin  of  land,  there  is  no  special  outlay  for  rent  and 
hence  no  investment,  other  than  what  is  paid  for  labor,  entering 
into  the  calculations  of  the  entrepreneur.  Now  let  us  assume 
the  total  of  labor  employed  in  making  a  given  commodity  to 
remain  unchanged,  the  length  of  the  production  period  being 
increased  by  increasing  the  proportion  of  this  labor  invested 
in  the  earlier  stages  of  the  productive  process.  The  result 
would  be  an  increasing  proportion  of  equipment  to  labor  at 


BOHM-BAWERK  S  THEORY  OF    INTEREST        25 

this  qualification  we  may  accept  Bohm-Bawerk's 
proposition  in  regard  to  the  relative  productivity 
of  different  production  periods. 

Now  can  it  be  shown  that  the  greater  produc- 
tivity of  the  longer  processes  is  a  reason  for 
preferring  present  to  future  goods  or  earlier 
to  later  ones?  The  only  way  to  do  this  would 
be  to  show  that,  of  productive  processes  to  be 
begun  at  different  times,  those  with  an  earlier 
start  are  the  longer  and  consequently  more 
productive  ones,  or,  in  other  words,  that  post- 
poning a  process  of  production  means  shortening 
it  and  thereby  diminishing  its  productivity. 
But  a  shortening  of  postponed  enterprises  at 
a  sacrifice  of  productive  efficiency  would  be 
without  motive,  unless  it  be  permissible  to 
assume  that  whether  the  start  be  early  or  late, 
the  date  when  the  product  is  completed  is  the 
same.  It  is  as  if  we  had  to  decide  that  whether 
we  begin  in  1914  or  1915  or  1916,  the  product 
was  to  be  finished  on,  but  neither  before  nor 

the  later  stages.  The  entire  product  would  pass  through  the 
hands  of  the  laborers  at  the  latest  stages  and  their  output, 
therefore,  would  measure  the  productivity  of  the  whole  process. 
After  the  increase  of  the  production  period  has  brought  about 
the  maximum  amount  of  equipment  each  of  these  laborers 
could  use  effectively,  and  the  maximum  he  could  produce, 
further  extensions  of  the  process  would  result,  at  best,  in  no 
increase  and,  perhaps,  in  a  decrease  of  the  product  per  laborer. 
At  the  same  time  the  number  of  these  laborers  is  diminished 
as  more  of  them  are  shifted  to  the  earlier  stages.  The  outcome 
would  be  a  decline  in  the  total  product,  and  as  the  total  of 
labor  invested  was  assumed  to  remain  unchanged,  a  corre- 
sponding decline  in  the  amount  of  product  per  unit  of  labor 
invested.  A  further  extension  of  the  production  period  would 
be  to  no  one's  interest. 


26  PROFIT  AND  WAGES 

after,  a  definite  date  in  1917.  Obviously  such 
an  assumption  respecting  the  time  when  pro- 
ductive processes  must  yield  their  fruit,  is 
without  warrant  save  as  applied  to  exceptional 
cases.  Contracts  for  completing  buildings  or 
furnishing  supplies  within  a  certain  time  (not 
usually  on  a  definite  date)  are  common  enough, 
but  being  made  under  conditions  which  allow 
practically  no  choice  as  to  the  time  of  beginning 
work,  are  not  relevant  to  our  problem.  The 
only  occasions  for  comparing  productive  pro- 
cesses begun  at  different  times,  but  aiming  at 
completion  on  the  same  date,  would  be  those 
created  by  expected  events  or  opportunities 
of  a  temporary  and  unusual  character,  by  what 
German  writers  would  call  a  Konjunktur.  Such 
would  be  the  occurrence  of  an  international 
exposition,  the  opening  of  a  canal  or  of  a  new 
railway,  the  outbreak  of  a  war,  etc.  But  most 
economists  would  agree  that  there  is  a  difference 
between  a  Konjunktur  gewinn,  the  gains  of  a 
special  and  temporary  opportunity,  and  interest 
on  capital,  and  that  the  latter  income  must  be 
derived  from  some  more  constant  and  regular 
source.  As  regards  the  great  majority  of 
productive  operations  there  is  no  occasion  for 
comparing  the  results  of  processes  begun  at 
different  times  and  no  necessity  for  shortening 
postponed  processes  because  of  any  need  for 
completing  them  on  a  given  date.  It  is,  there- 
fore, impossible  to  prove  a  purely  technical  or 
productive  advantage  in  present  over  future 


BOHM-BAWERK  S  THEORY  OF  INTEREST        27 

possession  of  the  means  of  starting  a  productive 
enterprise.  The  only  conceivable  conditions 
under  which  such  a  "technical  superiority  of 
present  goods"  could  arise  are  too  exceptional 
and  restricted  to  form  the  basis  of  a  theory  of 
interest. 

The  greater  productivity  of  the  longer  process, 
of  the  larger  investment  of  capital,  under 
certain  conditions  and  within  certain  limits,  is 
a  fact  and  one  of  some  significance  to  the  theory 
of  interest.  Bohm-Bawerk  presents  it  as  the 
most  important  of  those  which  must  enter 
into  the  explanation  of  the  income  of  the 
capitalist.  In  the  writer's  opinion  he  does  not 
overestimate  the  relative  importance  of  the 
technical  factor.  It  is,  in  truth,  the  only  one 
of  those  given  by  him  that  constitutes  an 
essential  element  of  a  general  theory  of  interest. 
But  he  has  not  given  the  right  name  to  the  fact 
which  he  is  using.  It  is  not  a  superiority  of 
present  goods,  i.  e.,  a  technical  advantage 
of  present  over  future  possession,  but  the 
productive  advantage  of  having  a  certain  capital 
over  that  of  having  less  capital  or  none  at  all. 
It  may,  perhaps,  form  the  basis  for  a  kind  of 
productivity  theory,  but  it  cannot  be  fitted 
into  a  pure  agio  theory.  In  short,  it  does  not 
constitute  a  direct  and  immediate  cause  of 
preference  for  present  over  future  goods. 

In  a  more  remote  way,  however,  it  may  be 
the  cause  of  such  preference.  If  we  grant 
that  the  greater  productivity  of  the  longer 


28  PROFIT  AND  WAGES 

process  is  one  of  the  factors  causing  the  existence 
of  interest,  and  that  the  possibility  of  deriving 
interest  from  money,  or  goods  convertible  into 
money,  is  a  good  reason  for  wishing  to  have 
said  goods  or  money  now  rather  than  later, 
we  must  conclude  that  the  superior  productivity 
of  long  processes  is  indeed  a  ground  of  prefer- 
ence for  present  goods.  But  such  preference  is 
a  result,  and  not  as  Bohm-Bawerk  would  have 
it,  a  cause  of  the  existence  of  interest  on  capital. 
In  regard  to  the  "technical  factor"  we  may 
conclude,  therefore,  that  its  contribution  to 
the  creation  or  maintenance  of  interest  on 
capital  cannot  be  of  the  same  nature  as  that 
of  Bohm-Bawerk's  other  "causes  of  preference 
for  present  goods."  Bohm-Bawerk's  bias  in 
favor  of  unitary  theory,  or,  as  Landry  calls  it, 
his  "fear  of  eclecticism,"  has  apparently  led 
him  to  make  a  desperate  attempt  to  demonstrate 
the  technical  factor  to  be  a  direct  cause  of 
preference  for  present  goods,  parallel  in  its 
action  with  the  other  two  factors.  Such  an 
attempt  must  necessarily  fail  and  the  three 
"causes"  cannot  be  brought  together  under 
one  head.  If  all  three  are  to  be  retained  for 
the  explanation  of  interest,  a  theory  resting 
on  time-preference  alone,  a  pure  agio  theory, 
is  an  impossibility. 


CHAPTER  III 

THE   TIME-PREFERENCE    THEORY 

The  conclusion  reached  in  the  preceding 
chapter  that  Bohm-Bawerk's  technical  factor 
will  not  fit  into  a  pure  agio  theory,  is  that  held 
by  apparently  the  great  majority  of  economists. 
With  some  qualifications,  perhaps,  this  factor 
may  form  the  basis,  of  a  kind  of  productivity 
theory.  It  cannot  be  made  to  appear  as  a 
direct  cause  of  a  preference  for  having  goods 
at  one  point  of  time,  rather  than  at  another. 
But  now  arises  the  question  as  to  whether  a 
satisfactory  theory  may  be  reached  by  elimi- 
nating the  technical  factor  from  consideration 
and  operating  with  the  other  two  causes  of 
preference,  those  which  a  careless  but  con- 
venient usage  permits  us  to  call  the  subjective 
factors.  This  has  been  the  method  of  several 
recent  writers*  and  may  be  regarded  as  a  very 
consistent  development  of  the  tendency  to 
reduce  economics  to  a  theory  of  valuation.  It 
merits  a  careful  examination.  But  instead  of 
assuming  the  active  existence  of  the  subjective 
factors  and  inquiring  merely  into  their  sufficiency 
to  give  a  complete  theory,  it  is  necessary  to 
approach  the  problem  in  a  more  fundamentally 
sceptical  attitude  and  to  ask  whether  these 

*Especially  Professors  Fetter  and  Irving  Fisher. 


30  PROFIT  AND  WAGES 

factors  actually  play  any  part  whatever  in 
bringing  about  the  existence  of  interest  or  in 
regulating  its  amount  and  percentual  rate. 

Let  us  then  take  a  glance  at  the  two  non- 
technical or  subjective  causes  of  preference 
mentioned  by  Bohm-Bawerk.  In  regard  to  the 
second  of  these,  the  underestimate  of  future 
advantages,  it  may  be  admitted  that  lack  of 
imagination,  weakness  of  will  in  the  face  of  the 
temptations  of  present  enjoyment,  the  uncer- 
tainty of  human  life  and,  perhaps,  other  cir- 
cumstances, may  bring  about  a  tendency  to 
over-rate  present  compared  with  future  goods. 
This,  of  course,  is  acknowledging  the  existence 
of  uneconomic  tendencies.  It  is  admitting  the 
irrational,  the  uneconomic  man  as  a  disturbing 
force  into  the  beautifully  ordered,  rational 
world  of  economic  theory.  Yet  if  actual  man- 
kind is  so  irrationally  disposed,  why  not  recog- 
nize the  fact  in  economic  study?  Doubts 
regarding  the  importance  of  the  factor,  arise, 
however,  when  we  ask  whether  persons  whose 
preference  for  present  goods  rests  on  such 
weakly  human  grounds  are  likely  to  be  in  a 
position  to  offer  sufficient  security  for  the 
fulfillment  of  contracts,  to  be  enabled  to  enter 
into  an  exchange  of  future  for  present  goods. 
The  important  question  in  this  connection,  in 
fact  the  only  relevant  question,  is  not  whether 
such  preference  for  present  goods  might  or  does 


THE  TIME-PREFERENCE  THEORY  31 

exist,  but  whether  it  plays  a  part  in  the  business 
facts  that  give  rise  to  interest  on  loans  and 
investments. 

And  the  same  remark  applies  to  Bohm-Bawerk's 
first  cause  of  preference  for  present  possession. 
We  may  grant  that  an  anticipated  relatively 
more  abundant  provision  for  future  wants  is 
an  experience  entering  into  the  lives  of  a  con- 
siderable number  of  persons.  That  is,  they 
have  such  anticipations,  whether  or  not  these 
lead  to  any  conscious  preference  for  present 
goods  or  to  actual  offers  of  a  premium  for 
present  possession.  That  it  is  the  experience 
of  the  majority  may  perhaps  be  doubted  and 
it  is  not  impossible  that  conditions  may  be 
reversed  and  the  present  be  the  relatively  better 
provided  for.  In  that  case  it  would  be  rational 
to  feel  a  preference  for  future  over  present  goods. 
This  possibility  is  hardly  referred  to  by  Bohm- 
Bawerk,  whose  thinking  is  directed  toward 
finding  the  explanation  of  interest  in  what  he 
considers  the  almost  universal  human  attitude 
of  a  preference  for  goods  in  the  present.*  Of 
course  those  who  prefer  future  goods  to  present 
goods,  might  be  represented  along  with  those 
having  only  a  slight  preference  for  present  goods, 
as  parties  to  an  exchange  with  those  feeling  a 
relatively  strong  preference  for  goods  in  the 
present.  But,  on  the  whole,  the  agio  theory 

*However,  he  holds  that  for  most  capitalists  this  preference 
rests  on  the  "technical  superiority"  of  present  goods  and  that 
the  first  two  grounds  of  preference,  the  subjective  ones,  are 
of  no  effect.  See  3d  ed.  of  Positive  Theorie,  p.  521. 


32  PROFIT  AND  WAGES 

requires  that  preference  for  present  goods  be  a 
more  urgent  and  wide  spread   factor  than  the 
preference  for  future  goods.      If  such   should 
not  be  the  case,  that  is  if  those  preferring  present 
goods  could  always  find  persons  with  a  prefer- 
ence for  future  goods,    an  exchange  might  be 
arranged,    advantageous   to    both    parties,     in 
which  no  interest  or  discount  need  appear.    Now 
does  Bohm-Bawerk's  first   "cause,"   the  factor 
of  a  difference  between  provision  for  present 
and  for  future  wants,  take  a  shape  such  as  to 
create  a  very  general  preference  for  goods  in 
the  present?     It   appears,   at  least,    doubtful. 
Those  whose  income  is  gained   by  their  own 
labor,   may  in  youth  have    before    them    the 
prospect  of  earning  power  increasing  with  age 
and  experience;    but  such  increase  of  income 
may  be  accompanied  by  the  increased  expenses 
of  a  growing  family,  and  will  be  followed  by  a 
decline  of  earning  power  with  advancing  years. 
Those,    on   the   other  hand,    whose   income   is 
derived    from   investments,    may   have   reason 
for  expecting  a  constant  growth  of  income  from 
their  increasing  accumulation  of  savings.    Their 
relative  underestimate  of  future  goods  would 
however  be  due  to  the  existence  of  income  on 
capital.    To  represent  it  as  a  cause   of  interest 
would  obviously  be  reasoning  in  a  circle. 

Bohm-Bawerk's  first  two  grounds  of  prefer- 
ence for  present  goods,  the  subjective  factors, 
appear,  therefore,  to  offer  no  very  secure  founda- 
tion to  a  theory  of  interest.  In  fact,  Bohm- 


THE  TIME-PREFERENCE  THEORY  33 

Bawerk  himself  virtually  surrenders  them  except 
in  his  theory  of  the  "consumption  loan."  The 
exponents  of  the  pure  agio  theory,  however, 
have  put  forward  no  other  grounds  of  such 
preference.  They  rest  their  case  entirely  on 
something  for  which  no  adequate  explanation 
has  been  given. 

But  for  the  sake  of  argument  let  us  grant 
that  there  may  be  good  reasons  for  wishing  to 
have  goods  at  one  time  rather  than  at  another, 
and  that,  on  most  occasions  the  preference 
would  be  for  goods  in  the  present.  For  any 
preference,  one  way  or  the  other,  between  goods 
to  be  got  at  different  points  of  time,  we  may 
use  the  convenient  term  time- preference.*  When 
such  preferences  are  presented  as  growing  out 
of  fairly  definite,  quantitative  comparisons,  we 
evidently  have  an  extension  or  development  of 
the  Austrian  theory  of  value;  the  "economic 
man"  being  represented  as  comparing  the  rela- 
tive utilities  not  only  of  different  goods  in  the 
present  and  immediate  future,  but  of  the 
prospective  goods  of  years  to  come.  Interest 
becomes  a  problem  in  "subjective  value."  For 
let  us  note,  that  when  Bohm-Bawerk's  technical 
factor  is  eliminated  from  consideration,  the 
comparison  between  goods,  or  between  the 


"This  term  is  used  by  Professor  Irving  Fisher  but  in  a  more 
restricted  sense,  as  a  preference  for  present  over  future  goods. 
( The  Rate  of  Interest,  p.  88  and  elsewhere.)  In  Professor 
Fetter's  Economics  the  term  time-value  is  used  in  the  sense 
in  which  time-preference  is  employed  here. 


34  PROFIT  AND  WAGES 

"incomes"  from  goods  coming  at  different 
points  of  time,  is  made  by  the  consumer  and 
between  consumable  goods  only. 

This  may  arouse  doubts  in  regard  to  the 
applicability  of  the  theory  to  those  facts  in 
which  the  consensus  of  opinion  among  econo- 
mists looks  for  the  chief  source  of  interest. 
What  part  do  the  factors  it  emphasizes  play 
in  real  business?  When  capital  goods  or  profit- 
able opportunities  are  valued,  it  is  on  the 
basis  of  expected  pecuniary  returns,  of  that 
interest  whose  nature  and  amount  the  theory 
in  question  seeks  to  explain,  of  the  objective 
facts  of  the  industrial  world  rather  than  of  the 
subjective  states  of  the  consumer.  How  to 
bridge  the  gulf  between  the  subjective,  the 
consumer's  estimates  of  goods,  and  the  objective 
facts  of  industry,  constitutes  a  serious  problem 
for  those  who  would  base  interest  on  time- 
preference  alone. 

What  are  the  actual  mental  states  of  the 
men  who  put  their  capital  into  business  and 
get  an  income  in  the  shape  of  interest?  The 
professorial  imagination  has  displayed  great 
ingenuity  in  showing  how  comparisons  between 
present  and  future  utilities  might  be  made  and 
time- values  noted.  But  such  mental  exercises 
are  of  no  importance  unless  time-preference  is 
a  psychic  state  that  actually  enters  into  the 
transactions  out  of  which  interest  grows;  unless 
it  plays  a  part  in  borrowing,  lending,  and 
investing.  The  only  relevant  question,  there- 


THE  TIME-PREFERENCE  THEORY  35 

fore,  is  not  that  as  to  possible  reasons  for  having 
a  time-preference,  or  as  to  the  possibility  of 
the  occurrence  of  this  state  of  mind,  but  as  to 
whether  such  a  preference  or  valuation  is  an 
essential  part  of  the  psychology  of  business. 
What  really  goes  on  in  the  investor's  mind? 
In  the  borrower's  and  in  the  lender's  mind? 

That  economists  have  been  so  ready  to  accept 
time-preference  as  a  factor  affecting  invest- 
ment is  possibly  due  to  an  uncritical  identifica- 
tion of  it  with  the  older  concept  of  abstinence; 
the  transition  from  the  older  to  the  more  recent 
conception  being  facilitated  by  the  use  of 
such  terms  as  postponement,  prospectiveness, 
and  waiting.  In  the  idea  of  an  exchange  of 
present  against  future  goods  in  which  time- 
preference  may  play  a  part,  we  have,  however, 
something  essentially  different  from  the  thought 
of  the  older  abstinence  theorists,  and  a  view 
of  things  less  likely  to  recommend  itself  to  an 
unsophisticated  understanding  of  what  takes 
place  in  this  world.  By  the  older  writers 
abstinence  was  taken  to  mean  abstaining  from 
consumption  in  order  to  accumulate  and  invest 
capital,  and  the  continuance  of  the  abstention 
in  order  to  maintain  the  capital  accumulated. 
It  was  regarded  as  involving  some  deprivation 
or  "cost"  and,  therefore,  requiring  some  com- 
pensation. Interest  was  the  necessary  "reward 
of  abstinence."  This  view,  however,  did  not 
of  necessity  imply  that  in  the  exercise  of  absti- 
nence there  was  a  postponement  of  consumption, 


36  PROFIT  AND  WAGES 

i.  e.,  that  the  capital  sum  saved  and  maintained 
by  abstinence,  was  ever  to  be  consumed.  Such 
an  idea,  however,  is  suggested  by  Bohm-Bawerk's 
exchange  of  present  for  future  goods.  It  implies 
in  the  capitalist's  mind  a  comparison  of  two 
quantities  of  consumable  goods;  of  a  present 
quantity  on  the  one  hand,  with  an  equal  future 
quantity  of  goods,  in  addition  to  the  interest, 
on  the  other. 

This  manner  of  presenting  the  calculations 
of  investors  is  an  obvious  departure  from  the 
facts,  a  misrepresentation  of  the  psychology  of 
investment.  Very  few  investors  ever  con- 
template consuming  what  they  call  their  capital. 
Investment  to  them  does  not  mean  postponing 
the  consumption  of  the  equivalent  of  what  they 
have  saved.  In  fact,  whatever  hardship  or 
cost  may  have  been  involved  in  saving  a  given 
capital,  it  would  probably  appear  a  more 
heartrending  thing  to  be  obliged  to  consume  the 
capital  that  has  been  saved.  The  capital  sum, 
therefore,  does  not  enter  into  both  terms  of 
the  comparison  between  present  and  future 
goods.  What  the  investor  does  is  to  compare 
the  present  or  early  consumption  of,  let  us  say, 
one  thousand  dollars  worth  of  goods  once  and 
for  all,  with  the  later  consumption  of  a  per- 
manent, annual  income  of  fifty  dollars  worth 
of  goods,  obtainable  without  labor.  There  is 
a  comparison,  indeed,  of  consumable  goods, 
or  if  you  will,  of  "psychic  income"  or  utilities 
of  goods ;  but  it  is  of  goods  or  income  appearing 


THE  TIME- PREFERENCE  THEORY  37 

under  very  different  conditions.  The  one  thou- 
sand dollars  if  spent  for  purposes  of  consumption 
are  gone.  Another  accumulation  of  one  thousand 
dollars  can  be  obtained  perhaps  only  by  per- 
forming labor.  The  fifty  dollars  received  as 
interest,  may  be  spent,  but  an  equivalent  sum 
will  come  again,  year  after  year,  and  without 
exacting  labor  from  the  investor.  A  relatively 
large  temporary  satisfaction  of  wants  may  be 
given  up  when  one  thousand  dollars  is  saved; 
a  permanent,  unlaborious  recurrence  of  a  much 
smaller  sum  is  gained.  The  permanent  char- 
acter of  interest  income  and  the  fact  that  it 
comes  without  labor  on  the  part  of  the  recipient, 
are  to  the  capitalist  the  significant  character- 
istics of  the  "future  goods"  he  purchases  by 
means  of  his  "present  goods."  These  real  or 
apparent  characteristics  a  theory  of  interest 
must  account  for.  Their  existence  granted, 
we  can  see  why  men  will  make  sacrifices  to 
obtain  interest. 

In  the  case  of  the  active  entrepreneur,  as 
distinguished  from  the  capitalist-lender,  the 
calculations  of  an  investment  are  slightly  differ- 
ent, but  equally  unfavorable  to  the  time- 
preference  concept.  The  entrepreneur  also  hopes 
to  get  a  permanent  income  as  a  percentual 
rate  of  his  thousand  dollars;  but  he  looks  for 
a  higher  rate  than  the  capitalist,  for  what 
following  the  usage  of  the  classical  economists, 
we  may  call  "profits  of  capital."  When  receiving 
the  higher  rate  he  does  not  expect  entirely  to 


38  PROFIT  AND  WAGES 

avoid  risk  and  labor.  The  most  important 
aspect  of  investment  to  him  is  the  fact  that  it 
represents  business  opportunity.  Neither  cap- 
italist, nor  entrepreneur,  however,  let  a  future 
capital  sum  enter  into  comparison  with  present 
goods.  They  are  not  conscious  of  making  any 
such  exchange  of  present  against  future  goods 
as  is  suggested  by  the  language  of  Bohrri- 
Bawerk  and  his  followers. 

It  is  evident  that  the  purposes  and  calcula- 
tions that  lead  up  to  and  prevail  in  the  process 
of  investment  are  not  those  suggested  by  the 
theory  under  consideration.  Time-preference 
is  certainly  not  consciously  present  and  it  is 
hard  to  see  how  the  institution  of  interest  can 
rest  upon  a  mental  state  which  capitalists  would 
fail  to  recognize  as  having  any  connection  with 
their  business.  Indirect  evidence,  moreover, 
that  estimates  of  time  value  are  not  an  important 
factor  may  be  found  by  considering  the  rates 
of  interest  on  loans  for  different  lengths  of 
time.  If  a  comparison  of  the  utility  or  value 
of  the  capital  sums  loaned  and  returned,  or 
of  the  goods  these  sums  represent,  played  any 
part,  then  the  longer  the  time  intervening 
before  the  payment  of  the  loan,  the  higher  the 
agio  or  total  of  interest  necessary  as  premium 
on  present  goods  or  discount  of  the  distant 
future  goods.  If  the  preference  for  present 
possession  grew  in  direct  ratio  with  the  length 
of  the  loan  period,  a  uniform  annual  rate  of 
interest  would  be  demanded  for  all  loans  of 


THE  TIME-PREFERENCE  THEORY  39 

equal  risk.  A  thirty  year  loan  of  one  thousand 
dollars,  for  instance,  would  receive  six  times  as 
many  annual  payments  of  fifty  dollars  as  a 
five  year  loan.  But  perhaps  it  may  be  argued 
that  if  time  preference  governs  the  loan  market, 
a  prospect  of  payment  at  a  very  distant  date 
would  call  for  a  higher  rate  of  discount  than  a 
short  period  loan,  that  if  a  five  year  loan  is 
satisfied  with  5  x  $50,  a  thirty  year  loan  would 
demand  3ox$6o;  preference  for  present  goods 
and  sums  growing  at  a  greater  rate  than  the 
time  interval  before  the  final  payment.  The 
facts  of  the  loan  market,  however,  do  not  fit 
either  of  the  above  suppositions  as  to  the  rate 
of  growth  of  preference  for  present  possession 
with  increasing  remoteness  of  future  payments, 
and  do  not,  therefore,  fit  the  necessities  of  the 
time-preference  theory.  Instead  of  a  rate  of 
interest  on  long  time  loans  equal  to  or  greater 
than  that  on  short  loans,  we  usually  have  a 
lower  rate ;  evidence  that  an  undisturbed  annual 
income  is  desired  and  not  the  return  of  the 
whole  equivalent  of  the  "present  goods"  invested. 
Something  needs  to  be  said  about  the  idea 
of  an  exchange  of  present  against  future  goods 
which  has  played  more  or  less  of  a  part  in  the 
agio  theory.  The  term  "exchange"  suggests 
two  parties.  "It  takes  two  to  make  a  trade." 
The  investor  or  capitalist  gives  present  goods  in 
return  for  future  goods.  But  who  is  it  that 
gives  the  future  goods?  In  the  so-called  "con- 
sumption loan"  the  borrower  appears  clearly 


40  PROFIT  AND  WAGES 

to  be  the  one  who  offers  things  in  the  future. 
But  the  consumption  loan  is  one  of  the  minor 
incidents  of  the  modern  economic  system  and 
may  be  passed  over  for  the  present.  If  it  is 
not  possible  to  make  the  idea  of  a  trade  in 
time-values  fit  the  facts  of  the  "production 
loan"  and  the  use  of  capital  in  business,  the 
major  characteristics  of  the  capitalistic  world, 
it  is  evident  that  the  factors  suggested  by  it 
can  play  at  most  a  very  subordinate  part. 

Turning,  therefore,  to  the  production  loan, 
we  ask,  who  are  the  parties  to  an  exchange  in 
which  present  goods  are  given  for  future  goods? 
Is  there  such  an  exchange  between  the  capitalist 
as  lender  and  the  entrepreneur  as  borrower? 
The  capitalist  gives  up  present  goods  to  the 
entrepreneur.  The  latter,  however,  far  from 
consuming  them,  turns  them  into  his  business 
and  looks  for  a  future  return.  Obviously  both 
entrepreneur  and  capitalist  look  for  a  future 
return.  They  share  in  the  profits  of  capital. 
The  capitalist  because  free  from  risk  and  the 
labor  of  directing  the  productive  and  com- 
mercial process  contents  himself  with  a  part 
of  these  profits  known  as  interest.  Interest  is 
"commuted  profits."*  What  is  really  given 
in  exchange,  therefore,  is  not  consumable  quan- 
tities of  wealth  of  different  date  —  like  the 
dinners  of  polite  society  -  -  but  different  means 
and  conditions  of  securing  income.  The  entre- 
preneur receives  the  means  of  controlling  the 

*Hadley,  Economics,  p.  270. 


THE  TIME-PREFERENCE  THEORY  41 

productive  or  business  process,  the  opportunity 
of  making  a  gain  by  luck  and  the  exercise  of 
his  business  talents.  The  capitalist,  on  the 
other  hand,  receives  an  income  without  labor 
and  often  substantially  without  risk.  But 
both  devote  present  wealth  to  future  income. 
If  anywhere  there  is  an  exchange  of  present 
against  future  goods,  it  is  not  between  entre- 
preneur and  capitalist.  We  must  look  else- 
where for  an  answer  to  the  question  as  to  who 
gives  the  future  goods. 

If  there  is  an  actual  exchange  of  earlier  for 
later  goods,  connected  in  any  way  with  the 
capitalistic  production  of  wealth,  apparently 
it  must  be  between  entrepreneur  and  laborer, 
the  laborer  being  the  seller  of  future  goods. 
Now  the  wage  contract  may  indeed  be  regarded 
as  an  exchange,  but  not  as  a  conscious  exchange 
of  time- values.  The  laborer  knows  nothing 
of  giving  future  goods.  He  has  no  goods  to 
give,  either  now  or  in  prospect.  As  Loria 
remarks,  he  is  not  so  fortunate  as  to  compete 
with  the  Roman  Church  in  its  traffic  in  future 
blessings.*  He  has  only  his  labor-power.  That 
may  be  used  to  produce  goods  which  are  to  be 
finished  and  sold  in  the  future,  and  so,  by  figure 
of  speech,  these  products,  and  the  labor-power 
itself,  may  be  called  "future  goods."  But  this 
labor-power  is  a  future  good  that  can  seldom 
"ripen"  into  a  present  good  unless  the  employer 
consents  to  take  it  into  his  hire.  So  all  that  will 

*//  capitalismo  e  la  scienza.     Chap.  I. 


42  PROFIT  AND  WAGES 

be  clear  to  the  employe's  mind  is  that  with  the 
employer's  consent,  he  may  work  and  receive 
wages.  The  goods  he  makes,  he  cannot  think  of 
giving  in  return  for  anything,  because  they 
are  not  his  to  give.  All  the  characteristic  features 
of  an  exchange  are  lacking.  Yet  if  interest  is 
to  be  accounted  for  as  the  agio  in  an  exchange 
of  time- values,  the  employe  must  be  represented 
as  giving  commodities  which  he  may  never 
see  in  their  completed  form,  whose  amount  and 
value  he  does  not  know,  and  —  giving  them 
subject  to  a  discount.  That  discount,  if  there 
is  a  conscious  trade  in  time- values,  should 
satisfy  the  time-preference  of  both  employer 
and  laborer.  But  it  requires  no  argument  to 
show  that  the  laborer  knows  nothing  about  such 
a  discount.  If  he  has  not  read  the  latest  theorist 
he  does  not  suspect  that  he  has  a  rate  of  time- 
preference  at  all.  Was  any  such  rate  ever  men- 
tioned in  the  contest  between  trade-union  and 
employer? 

Possibly  the  obvious  absurdities  of  the  idea 
of  an  exchange  when  applied  to  the  wage- 
contract,  —  the  one  business  relation  in  which 
present  goods  appear  to  be  given  for  future  goods 
on  a  large  scale  —  are  not  necessary  implica- 
tions of  the  time-preference  theory.  Perhaps 
the  use  of  the  term  "exchange"  is  simply  an 
instance  of  unhappy  terminology  and  may  be 
avoided.*  It  might  be  argued  that  although 

*It  may  be  suspected  that  if  it  were  not  for  the  apparent  apolo- 
getic value  of  the  idea  of  an  exchange  between  present  and 
future  goods,  the  idea  would  have  received  little  notice. 


THE  TIME-PREFERENCE  THEORY  43 

the  laborer  is  no  conscious  buyer  or  seller  of 
time- values,  the  time-preference  rate  of  cap- 
italist and  employer  determines  the  rate  of 
profit  and  interest.  In  that  case,  in  trying  to 
demonstrate  a  general  preference  for  present 
over  future  enjoyment,  the  time-preference 
theorist  may  eliminate  the  laboring  classes  from 
consideration  as  irrelevant  to  the  subject.* 

To  state  the  possibly  consistent  time-prefer- 
ence theory  which  may  be  reached  by  dis- 
carding the  idea  of  a  conscious  bargain  in  time- 
values  between  employer  and  employe,  —  the 
laborer  might  be  represented  as  merely  selling 
his  labor  for  what  he  can  get,  while  employers 
are  led  by  competition  to  pay  the  discounted 
value  of  the  product  of  that  labor,  the  rate  of 
discount  being  determined  by  the  capitalist's 
rate  of  time-preference.  This,  of  course,  is 
possible  only  on  the  assumption  that  capitalists 
prefer  present  to  future  goods  and  at  a  definite 
rate  of  preference  (at  least,  so  far  as  the  marginal 
supply  of  capital  is  concerned).  That  the  com- 
petition of  employers  will  give  the  laborer  the 
full  product  of  his  labor  discounted  at  not 
more  than  the  "necessary"  rate  of  discount, 
is  of  course  one  of  the  cheerful  assumptions  of 

*The  time-preference  of  laborers  is  of  significance,  in  this  con- 
nection, only  in  so  far  as  laborers  are  capitalists  and  not  always 
even  then.  A  large  part  of  the  savings  of  the  working  class 
are  such  savings  "for  a  rainy  day"  as  would  be  made  even  if 
there  were  no  interest  receivable  upon  their  accumulations. 
We  may  infer,  therefore,  that  but  a  very  small  part  of  the 
capital  funds  of  the  world  are  affected  in  any  way  by  the 
preference  of  laborers  for  present  over  future  goods. 


44  PROFIT  AND  WAGES 

the  productivity  theory  of  wages.  This  assump- 
tion, as  will  be  shown  in  a  later  chapter,  is 
questionable.  Let  us  note  only,  that  if  one  is 
willing  to  accept  the  productivity  theory  of 
wages  in  the  form  just  stated,  and  also  the 
idea  of  a  definite  rate  of  time-preference  held 
by  capitalists,  we  can  get  a  very  consistent 
theory  of  the  rate  and  amount  of  interest  and 
profit  of  capital.  Capitalists  and  entrepreneurs 
as  a  class  pay  simply  wages,  nothing  more.* 
These  wages  according  to  the  theory  just 
suggested  are  the  discounted  value  of  the  total 
product,  the  discount  being  determined  by  the 
time-preference  rate  of  the  capitalist  class. 

This  theory  would  not  give  us  a  complete 
theory  of  why  there  is  interest  at  all.  A  complete 
explanation  of  the  existence  of  the  institution 
of  interest  and  profit  of  capital  would  have 
to  take  definite  cognizance  among  other  things 
of  the  existence  and  conditions  of  a  special 
class  so  situated  that  its  rate  of  time-preference, 
if  indeed  it  has  one,  can  play  no  part  in  deter- 
mining the  share  that  it  may  get  of  the  product 
of  its  labor.  But  the  formulation  of  a  complete 
theory  of  the  existence  of  interest  is  a  difficult 
and  probably  impossible  task.  In  our  view  the 
method  of  theory  should  attack  primarily  the 
problem  of  the  rate  and  amount  of  each  share 
in  distribution.  As  a  theory  of  the  rate  and 
amount  of  the  income  of  capital,  the  time- 

*Setting  aside  rent  and  taxes  and,  of  course,  all  payments  not 
connected  with  the  productive  process. 


THE  TIME-PREFERENCE  THEORY  45 

preference  theory,  as  we  have  seen,  may  be 
stated  in  fairly  consistent  form.  It  rests  on 
certain  dubious  assumptions  in  regard  to  the 
wage-contract,  which  will  be  reserved  for  later 
examination.  The  objection  against  the  theory 
to  be  stated  at  this  point,  however,  is  the  one 
suggested  by  our  analysis  of  the  psychology  of 
investment.  There  is  no  comparison  between 
present  and  future  capital  sums  and  no  dis- 
coverable definite  subjective  rate  of  time-prefer- 
ence in  the  minds  of  capitalists  and  entrepreneurs. 
Whatever  be  the  mental  states  of  these  gentle- 
men, they  are  not  those  suggested  by  this 
theory.  Whether  some  other,  happier  formu- 
lation of  the  subjective  condition  of  the  capitalist 
class  can  be  substituted  for  the  time-preference 
notion,  and  give  us  a  satisfactory  theory  of 
the  rate  and  amount  of  capitalist  gain,  may  be 
left  to  later  consideration.  At  this  point  we 
are  concerned  only  to  show  the  failure  of  the 
time-preference  theory. 

Other  than  the  contract  between  entrepreneur 
and  laborer,  the  only  transactions  that  suggest 
the  idea  of  an  "exchange"  of  present  for  future 
goods  are  the  loan  for  consumption  and  the 
purchase  of  durable  goods.  To  imagine  the 
parties  to  a  consumption  loan  as  adepts  in  the 
utilitarian  calculus,  with  definite  time-prefer- 
ences, may  be  less  difficult  than  most  of  the 
trials  of  faith  imposed  upon  us  by  the  time 
preference  theorists.  However,  it  seems  some- 
what doubtful  whether  actual  cases  of  such 


46  PROFIT  AND  WAGES 

mental  attitudes  are  discoverable.  In  any  case 
it  does  not  appear  probable  that  subjective 
factors  alone  could  account  for  the  rate  of 
interest  on  this  class  of  loans.  The  lender,  for 
instance,  is  less  likely  to  think  of  his  present 
and  future  "psychic  incomes,"  than  of  the  risk 
and  of  the  rate  of  pecuniary  return  on  the  various 
investments,  productive  and  unproductive,  open 
to  him.  Is  it  not  simpler  to  regard  the  interest 
payment  on  a  loan  for  consumption  as  a  deriva- 
tive phenomenon  and  look  for  a  fundamental 
theory  of  interest  in  the  circumstances  determin- 
ing the  income  on  productive  loans  and  invest- 
ments? After  all,  a  secondary  phenomenon  such 
as  the  consumption  loan  affords  too  narrow  a 
basis  to  support  a  comprehensive  theory  of 
capitalistic  income. 

When  we  come  to  consider  durable  goods, 
we  are  asked  by  the  time-preference  theorists 
to  regard  the  purchaser  as  buying  the  future 
utilities  or  services  given  by  these  goods  and, 
therefore,  estimating  the  value  of  the  goods 
he  buys  by  discounting  these  psychic  futurities. 
The  most  durable  of  all  purchasable  things  is 
land.  According  to  this  theory,  the  price  paid 
for  a  piece  of  land,  or,  in  other  words,  the 
present  goods  given  in  exchange  for  the  future 
goods  to  be  derived  as  income  from  the  land, 
must  equal  these  future  goods  discounted  accord- 
ing to  the  prevailing  rate  of  time-preference. 
The  price,  in  short,  is  the  present  value  of  a 


THE  TIME-PREFERENCE  THEORY  47 

seemingly  endless  series  of  annual  incomes.* 
Calculation  of  the  price  would  have  to  proceed 
by  adding  the  discounted  values  of  the  successive 
prospective  annual  returns  until  returns  so 
remote  were  reached  that  their  present  value 
is  infinitesimal.  Obviously  this  is  not  and 
never  was  the  method  followed  by  any  actual 
buyer  of  land. 

With  some  goods  of  a  less  durable  nature 
than  land,  as,  for  instance,  in  the  case  of  a 
dwelling  house,  the  calculation  supposed  by 
the  time-preference  theory,  may  seem  less 
absurd.  But  how  is  it  with  goods  of  a  still  less 
durable  character,  a  piece  of  cheap  furniture, 
for  instance,  or  a  suit  of  clothes,  or  a  box  of 
cigars?  Their  utilities  are  spread  out  over 
future  time.  Do  we  discount  these  utilities 
when  we  think  of  buying  the  articles?  All, 
even  the  most  evanescent  goods,  are  to  be 
consumed  at  a  future  moment,  though  that 
future  be  but  a  fraction  of  a  second  removed 
from  the  present.  Must  we  be  prepared  to 
view  the  discounting  of  "psychic  income"  as 
entering  into  the  determination  of  all  commodity 
values?  Here  obviously  we  are  beginning  to 
approach  the  absurd. 

Now  possibly  the  application  of  its  funda- 
mental principle  to  the  value  of  consumption 
goods  is  not  necessary  to  the  time-preference 
theory.  It  has  been  referred  to  here  to  show 
how  far  the  bias  in  favor  of  psychological 

*Bohm-Bawerk  does  not  hesitate  to  call  it  an  "infinite"  series. 


48  PROFIT  AND  WAGES 

theory  has  led  the  exponents  of  time-preference 
away  from  reality.  If  economics  must  get 
back  to  subjective  factors,  why  not  consider 
income  as  consisting  of  utilities  rather  than  of 
the  goods  giving  these  utilities?  And  if  utilities 
are  income,  why  should  not  the  income  be 
capitalized?  In  other  words,  why  not  arrive 
at  the  value  of  a  cigar  by  discounting  the 
prospective  pleasures  of  a  smoke?  "Logic 
is  logic"  even  when  it  leads  to  absurdity.  But 
obviously  the  unblenching  stibjective  valuation- 
ists  have  led  economic  theory  far  from  the 
observable  facts  of  industrial  life. 

The  departure  from  reality  has  come,  of 
course,  by  stages.  As  Private  Mulvaney  would 
say,  "one  thing  led  to  another."  First,  we  were 
given  the  "economic  man"  -not  a  real  man 
but  supposed  to  be  enough  like  a  man  of  business, 
during  business  hours,  to  illustrate  what  might 
happen  in  the  industrial  world.  Then  this 
"economic  man"  developed  into  a  Benthamite 
psychologist,  but  ever  growing  more  subtle 
in  his  thinking,  weighing  and  comparing  utilities 
-  after  a  time  even  of  infinitesimal  increments. 
Differential  calculus  was  called  upon  to  demon- 
strate the  precision  of  his  thought.  When 
after  a  time  the  feeling  of  strangeness  had 
worn  off  and  our  economist  Frankensteins 
began  to  feel  at  ease  with  their  monstrous 
creation,  they  saw  that  the  clever  creature 
could  not  be  confined  to  estimating  utilities 
that  are  all  within  one  area  or  zone  of  time, 


THE  TIME-PREFERENCE  THEORY  49 

as  if  he  had  no  sense  of  time  at  all.  No,  he  must 
look  ahead  and  project  his  arrangement  of 
utilities  far  into  the  future.  So  carefully  does 
he  distribute  his  consumption  of  commodities 
over  the  days,  months,  and  years,  that  the 
least  want  satisfied  at  any  moment  of  time 
has  the  same  importance  as  the  marginal  want 
satisfied  at  any  other  moment.  If  by  some 
investment  of  wealth,  he  disturbs  his  beautiful 
equilibre  de  la  consommation,  he  knows  exactly 
what  rate  of  interest  he  must  demand  to  com- 
pensate for  the  cost  of  this  disturbance.*  Such 
are  the  achievements  of  this  hero  of  economic 
mythology.  He  has  delighted  our  fancy,  but 
the  time  has  come  to  ask  whether  anybody 
ever  saw  anything  like  him  in  sober  reality. 
And  it  is  reality  which  economists  profess  to 
describe,  though  of  necessity  employing  the 
method  of  abstraction.  By  "successive  approxi- 
mations," we  have  been  led  to  hope,  the  abstrac- 
tions of  economic  theory  could  gradually  close 
in  upon  reality,  almost  attaining  it.  But 
obviously  there  are  economic  speculations  that 
act  more  like  successive  dispersions  from  the 
facts  of  life. 

Of  course,  we  may  expect  that  soon  or  late 
there  will  appear  a  sceptical  reaction  against 
the  development  of  the  principle  of  subjective 
valuation,  and  a  disposition  to  appeal  to  the 
coarse  judgments  of  the  popular  consciousness. 
Thus  Lexis  writes  in  opposition  to  the  agio 

"Landry,  L'interet  du  capital,  Chap.  II. 


5o  PROFIT  AND  WAGES 

theory  —  though  apparently  thinking  only  of 
Bohm-Bawerk's  exposition  and  not  of  the  fine- 
spun developments  of  recent  writers  —  that 
"the  question  of  the  significance  of  a  time- 
difference  —  the  distantia  temporis  —  between 
the  beginning  and  end  of  a  loan-transaction 
*  *  *  was  considered  by  the  Canonists.  The 
profit  on  a  bill  of  exchange  was  justified  by  the 
difference  in  monetary  standards  and  the  dis- 
tance between  the  place  where  the  bill  was 
drawn  and  the  place  of  payment.  But  for  the 
time  difference  all  compensation  was  uncon- 
ditionally excluded  —  evidence  that  the  idea 
of  a  difference  in  value  between  a  present  and 
a  future  sum  was  as  remote  from  the  economic 
consciousness  of  that  time  as  it  is  from  the 
minds  of  the  money  lenders  and  house  owners 
of  today.  But  motives  and  considerations 
which  do  not  demonstrably  and  consciously 
determine  the  actions  of  individuals  and  thereby 
cause  collective  phenomena  (Massenwirkungeri) 
cannot  be  regarded  as  factors  of  any  importance 
in  political  economy  (wesentliche  Faktoren  fur 
die  Volkswirtschaft) . "  * 

Possibly  Lexis  carries  his  scepticism  too  far. 
The  refusal  to  consider  anything  but  factors 
which  are  demonstrable  and  conscious  to  the 
popular  mind,  might  exclude  actually  operating 
forces  from  examination.  The  popular  mind 
is  not  acute  in  analysis  nor  conscious  of  its  own 
processes.  If,  for  instance,  the  question  whether 

*Article  Zins  in  Worterbuch  der  Volkswirtschaft,   Bd.  II. 


THE  TIME-PREFERENCE  THEORY  51 

estimates  of  marginal  utility  entered  into  the 
ordinary  shopper's  mind,  were  submitted  to 
any  group  of  plain  people,  the  answer  probably 
would  be  an  hilarious  negative.  Yet  while 
the  average  man  would  find  it  difficult  to 
discover  by  introspection  any  of  the  subtle 
workings  of  the  utilitarian  calculus,  relative 
marginal  utility  may  after  all  have  some  influ- 
ence on  the  distribution  of  his  expenditures. 
Not  that  he  carefully  compares  utilities.  But 
if  the  marginal  utilities  of  different  lines  of 
expenditure  get  out  of  alignment  a  distressing 
insufficiency  at  some  point  will  lead  to  sober 
reflections  and  an  effort  to  make  a  better  pro- 
portioned provision  for  the  different  groups  of 
wants.  Moreover,  imitation  leads  to  a  dis- 
tribution of  expenditures  according  to  class 
standards,  the  outgrowth  of  the  experience  of 
the  class  and  its  gradual  but  not  clearly  conscious 
adjustment  of  expenditure  to  money  income. 
The  marginal  utilities  that  affect  the  relative 
demand  for  different  commodities  on  the  market 
are  to  a  large  degree  objective  facts  and  social 
standards  to  which  the  individual  conforms 
unconsciously. 

Thus  marginal  utility  although  not  recog- 
nized by  the  popular  mind,  is  a  factor  to  which 
economic  theorists  are  justified  in  giving  some 
recognition.  But  when  we  come  to  deal  with 
time- values  and  preferences,  we  are  entering  a 
sphere  where  even  the  roughest,  least  conscious 


52  PROFIT  AND  WAGES 

\ 

adjustment    of    expenditure   to    relative    needs 
seems  to  be  beyond  the  reach  of  probability. 
Manipulation  of  the   "time-shapes"   of  income 
is   practically   impossible.      To   be   sure,    some 
successful    spreading    of    expenditure,    of    the 
"psychic  income"    of  the   consumer,   over  the 
week,  the  month,  even  over  the  year  is  accom- 
plished.     It   has   been   the   study   of   many   a 
pedagogical  household.     But  who  would  claim 
that    this   has    any    perceptible    effect    on   the 
business  of  deriving  interest  from  capital  invest- 
ments?   For  longer  periods  of  time,  the  unfore- 
seeable   changes    in    subjective    and    objective 
conditions   of   life,    make  both   the   experience 
of  the  individual  and  of  social  classes   of  no 
avail    in    effecting    any    rational    equalization 
over  time,  of  the  stream  of  "psychic  income." 
We  have  a  right  to  demand  that  in  theorizing, 
more  definite  and  demonstrable  factors  be  taken 
than  the  "time-shape"  of  income,  "time- values," 
and  "rate  of  time-preference."    To  reach  general 
conclusions  economists  are  obliged  to  assume  the 
action  of  intelligent  self  interest,  to  picture  life 
as  more  rational  than  it  is  in  reality.    The  time- 
preference  theory,  however,  carries  rationalism 
to  excess.     By  attributing  superhuman  powers 
to   the   economic   man   it   becomes   completely 
detached    from    the    actual    world.      A    highly 
hypothetical  proposition,   subjected  to  succes- 
sive qualifications,  may  constitute  the  nucleus 
of   a   series    of   valuable    "approximations"    to 
reality.     If,  however,  the  first,   obvious  quali- 


THE  TIME-PREFERENCE  THEORY  53 

fication  is  a  complete  denial  of  the  initial 
hypothesis,  there  should  be  an  end  of  experiment 
with  such  fictitious  stuff.  The  time-preference 
theory  is  a  remarkably  consistent  piece  of 
theorizing  and  therein  doubtless  lies  its  great 
attraction.  But  it  is  spun  out  of  nothing. 

It  is  not  denied  that  expectations,  or  let  us 
say  rather  hopes  and  fears,  of  an  increase  or 
decrease  in  the  proportion  of  income  to  wants 
may  have  some  influence  on  saving,  lending, 
and  borrowing;  may  be  among  the  psychic 
conditions  out  of  which  these  acts  sometimes 
arise.  The  business  of  life  insurance  depends 
on  an  appeal  to  such  motives.*  The  amount 
of  savings  which  seek  interest-yielding  invest- 
ments may  be  affected  by  their  intensity. 
Influencing  the  supply  of  loan  funds  they  may 
have  some  influence  on  the  rate  of  interest.  But 
to  grant  that  these  expectations,  hopes,  and 
fears  have  an  influence  on  the  rate  of  interest  is 
far  from  admitting  that  they  are  a  direct 
determinant,  sufficiently  definite  and  powerful, 
to  be  given  a  place  in  a  carefully  formulated 
general  theory  of  the  rate  of  interest.  And 
in  any  case  they  are  subordinate  in  importance 
to  most  of  the  purposes  and  calculations  that 
rule  in  the  direct  investment  of  capital  in  the 

*It  should  be  noted,  however,  that  in  buying  life  insurance, 
the  one  really  clear  and  important  case  of  an  occasion  for 
comparing  amounts  of  consumable  wealth  of  different  periods 
with  reference  to  a  difference  in  the  state  of  provision  for  the 
wants  of  these  periods,  the  preference  is  for  future  goods,  and, 
therefore,  the  reverse  of  the  time-preference  called  for  by  the 
theory  under  consideration. 


54  PROFIT  AND  WAGES 

productive  process.  Of  these  calculations,  we 
have  seen,  the  concept  of  time  preference  gives 
a  false  notion.  We  may  conclude,  therefore, 
that  the  effort  to  reconstruct  Bohm-Bawerk's 
theory  by  etiminating  the  technical  factor  and 
basing  the  argument  exclusively  on  subjective 
estimates  of  time- value,  cannot  contribute  much 
to  the  elucidation  of  the  problem  of  interest. 
The  idea  of  a  sacrifice  of  present  goods  in  return 
for  future  goods  may  have  some  value  in  the 
apologetics  of  the  capitalistic  system.  That, 
however,  is  of  no  concern  to  disinterested 
economic  theory.  The  important  fact  is  that 
time-preference  has  too  little  relation  to  the 
actual  forces  at  work  in  the  industrial  world, 
to  serve  as  an  explanation  of  the  amount  and 
rate  of  capitalist  income. 


CHAPTER  IV 

THE  ABSTINENCE  THEORY 

The  controversial  success  of  the  Austrian 
theory  of  value  has  created  a  bias  in  favor  of 
explanations  of  economic  phenomena  in  terms 
of  subjective  valuation.  It  has  fostered  the 
ideal  of  a  unitary  theory  based  on  some  psycho- 
logical factor.  In  the  time-preference  theory 
of  interest  we  have  the  extreme  expression  of 
this  tendency.  It  is,  however,  the  only  modern 
psychological  theory  of  distribution  which  pro- 
fesses to  offer  all  the  elements  of  a  theory.  If 
we  reject  it,  we  must  turn  to  objective,  non- 
psychological  factors  for  at  least  part  of  the 
explanation  of  the  problem.  The  only  other 
theory  which  may  be  called  subjective  or 
psychological  is  the  abstinence  theory.  Recent 
adherents  of  the  latter,  however,  do  not  claim 
completeness  for  it.  It  is  advanced  as  a  treat- 
ment of  the  factor  of  supply  of  capital  only,  as 
part  of  a  dual  theory  of  interest  in  which  demand 
for  capital  is  described  as  starting  from  technical 
and  business  facts.  All  that  we  need  to  con- 
sider, therefore,  in  reference  to  this  theory  is 
whether  it  states  a  factor  affecting  supply  of 
capital  sufficiently  important  to  warrant  its 
inclusion  in  a  general  theory  and  whether  it 
correctly  represents  the  mechanism  by  which 
this  factor  comes  into  play. 


56  PROFIT  AND  WAGES 

In  favor  of  the  abstinence  theory  it  may  be 
said  that  it  gives  a  possibly  less  definite,  but 
also  less  questionable,  description  of  the  mental 
states  of  the  investor  than  the  time-preference 
theory.  In  some  modern  versions  the  concept 
of  abstinence  is  practically  converted  into  that 
of  time-preference.  It  is  possible,  however,  to 
formulate  the  abstinence  theory  in  such  a  way 
as  to  avoid  the  erroneous  conception  of  an 
exchange  of  present  against  future  goods  in 
the  form  of  an  exchange  of  a  present  capital 
sum  C,  against  a  lump  sum  C+i  (i  representing 
interest).  The  exchange  may  be  taken  to  be 
that  of  C  against  a  series  i,  i,  i,  i,  -  -  - 
of  regularly  recurrent  sums.  Abstinence  is 
represented  as  the  subjective  cost  of  a  per- 
manent, regularly  recurrent  (usually  annual) 
income,  obtained  without  labor. 

Now  does  this  theory  give  us  an  entirely 
acceptable  account  of  the  psychology  of  saving 
and  investment,  of  supply  of  capital?  The 
answer  will  depend  in  part  upon  whether  saving 
and  investment  really  involve  a  subjective  cost. 
If  the  term  abstinence  were  taken  to  mean 
merely  any  abstention  from  consumption  in 
favor  of  investment,  it  is  obvious  that  it  would 
frequently  involve  no  perceptible  subjective 
cost.  But  even  when  used  in  this  broad,  color- 
less sense,  the  term  would  be  too  narrow  to 
apply  to  the  mental  states  involved  in  all  cases 
of  investment.  In  many  instances  sums  are 
invested  that  would  not  have  been  spent  for 


THE  ABSTINENCE  THEORY  57 

consumption  goods  even  if  there  had  been  no 
possibility  of  investing  them.  In  such  cases 
there  is,  of  course,  no  abstention  or  abstinence 
from  consumption.  The  abstinence  theory  does 
not,  therefore,  at  least  in  its  cruder  form, 
convey  an  entirely  truthful  impression  of  the 
psychology  of  the  capitalist.  Its  implication 
of  a  subjective  cost  is  true  of  only  a  limited 
part  of  the  field  of  investment.  Saving  and 
investment  without  perceptible  subjective  cost 
or  hardship  occurs  not  only  when  there  is  an 
unspent  residuum  of  an  income  so  large  that 
it  would  be  distressing  to  the  recipient  to  find 
ways  of  spending  it.  The  maintenance  of  a 
capital  sum  once  saved  and  its  increase  by 
accumulation  at  compound  interest  probably 
means  little  subjective  cost  to  the  confirmed 
saver,  even  if  he  be  the  recipient  of  only  a  moder- 
ate income.  Besides  the  saving  of  individuals 
there  is  growing  up  an  increasingly  important 
saving  of  an  impersonal  character.  By  depre- 
ciation accounts,  the  managers  of  corpora- 
tions provide  for  the  maintenance  of  capital  . 
and  by  the  accumulation  of  surplus  for  an 
increase  of  capital,  without  the  slightest  con- 
sciousness of  abstinence  on  the  part  of  the 
majority  of  stockholders.  And  there  is  the 
"manufacture  of  credit"  by  banks.  Whether 
this,  however,  constitutes  an  increase  of  capital 
in  a  real  sense  is  a  disputed  point. 

It  must  be  recognized,  however,  that  modern 
expositions  of  the  theory  do  not  attribute  all 


58  PROFIT  AND  WAGES 

saving  and  investment  to  abstinence.  They 
aim  primarily  at  an  analysis  of  the  factors 
determining  the  rate  of  interest.  As  they  view 
the  matter,  it  is  the  subjective  cost  or  abstinence 
of  the  marginal  savings  that  is  just  paid  for  by 
the  rate  of  interest,  the  rate  established  by  the 
equalization  of  demand  and  supply.  Savings 
other  than  the  marginal  may  be  subject  to  little 
or  no  cost,  but  receive  the  benefit  of  the  rate 
that  must  be  paid  in  order  to  overcome  the 
marginal  saver's  reluctance  to  undergo  the 
necessary  abstinence.  The  greater  the  amount 
of  capital  available  throughout  the  field  of 
industry,  the  less  is  gained  by  its  use  at  the 
margin  and  the  lower  in  consequence  the  rate 
of  interest.  If  the  rate  rises  as  a  result  of 
greater  demand,  increased  savings  will  be  induced ; 
if  the  rate  falls,  the  marginal  savings  will  fall 
off  because  of  diminished  inducements.  It  is 
implied,  therefore,  by  the  theory,  that  saving 
rises  and  falls  with  the  rate  of  interest  though 
not  necessarily  in  the  same  degree.  Thus  it 
regulates  the  supply  of  capital  and  thereby  its 
marginal  gains,  in  such  a  way  as  to  establish 
a  rate  of  interest  that  pays  for  the  abstinence 
of  the  marginal  savings.  And  it  is  further 
implied  that  the  changes  in  the  supply  of  saving 
necessary  to  bring  about  this  equilibrium 
between  rate  and  abstinence,  are  in  the  saving 
which  can  be  called  marginal  and  involves  the 
cost  of  abstinence. 


THE  ABSTINENCE  THEORY  59 

The  interacting  factors  supposed  to  deter- 
mine the  rate  of  interest  are  stated  in  terms  of 
demand  and  supply.  This  gives  occasion  for 
some  criticism  of  a  more  or  less  formal  character. 
What  is  the  meaning  of  "supply"  of  capital? 
Is  it  the  supply  of  loan-capital  only  or  of  the 
total  of  capital  whether  borrowed  or  owned 
by  those  who  employ  it?  Since  the  demand  is 
represented  as  being  regulated  by  the  marginal 
"productivity"  of  capital,  and  this  depends  on 
the  total  of  capital  used,  it  is  necessary  to  take 
the  word  supply  as  signifying  the  total.  Now 
what  rate  have  we  to  consider  in  this  discussion 
that  of  profit  or  that  of  interest?  As  the  total  of 
capital  is  under  consideration,  it  is  evidently 
the  rate  of  profit.  Yet  the  theory  professes  to 
be  a  theory  of  interest.* 

If  the  rate  of  profit  and  that  of  interest  always 
varied  together  and  in  the  same  direction,  it 
would  not  be  misleading  to  represent  the  rate 
of  interest  by  that  of  profit  in  a  discussion  of 
the  interaction  of  demand  and  supply.  There 
are  theoretical  grounds  for  expecting  these 
two  rates  to  move  together.  There  appear  to 
be,  however,  historical  instances  of  their  failure 
to  do  so  and  even  of  their  going  in  opposite 
directions.  Now  as  saving  and  the  supply  of 

*Sometimes  the  return  on  marginal  investments  of  capital 
is  represented  as  being  interest  only,  the  entrepreneur  in 
search  of  profit  having  borrowed  capital  until  all  excess  of 
profit  over  interest  has  disappeared  on  the  last  portion  borrowed. 
Here  the  habit  of  thinking  of  infinitesimal  increments  has 
led  to  the  improbable  conclusion  that  entrepreneurs  will  do 
and  continue  to  do  things  which  result  in  no  gain  to  themselves. 


60  PROFIT  AND  WAGES 

capital  are  represented  by  the  theory  under 
discussion  as  being  in  response  to,  or  induced 
by,  a  rate  of  return,  there  arises  the  difficulty 
that  some  savers  are  affected  by  the  rate  of 
interest  alone,  others  by  the  rate  of  profit  as 
well  as  by  the  rate  of  interest.  Those  who  are 
capitalists  only,  unwilling  to  run  risks,  without 
ability  or  inclination  to  manage  a  business, 
will  not  in  their  saving  be  affected  by  the  rate 
of  profit  at  all,  unless  that  rate  in  its  movement 
drags  the  rate  of  interest  with  it.  The  entre- 
preneur, however,  in  his  saving  will  be  affected 
by  both  rates,  though  conceivably  in  conflicting 
ways.  If  the  rate  of  profit  declines,  he  has 
apparently  less  inducement  to  save  capital  than 
before.  If  at  the  same  time,  however,  the  rate 
of  interest  should  remain  unchanged,  or  should 
rise,  he  might  have  a  stronger  motive  than 
before  for  owning  the  capital  he  uses  instead  of 
borrowing.  Or  the  capitalist  and  investor  within 
him,  rather  than  the  entrepreneur  and  specu- 
lator, might  develop  and  feel  himself  drawn  to 
increased  saving  by  the  prospect  of  a  safe 
interest  return.  If,  however,  we  may  assume 
that  the  two  rates  move  in  the  same  direction 
and  in  such  degree  as  to  leave  always  the  same 
margin  between  them,  all  classes  of  savers  may 
be  regarded  as  affected  in  much  the  same  way, 
and  one  difficulty  of  the  theory  under  con- 
sideration will  be  overcome. 

We   have   seen   that   the   statement    of   the 
theory   of   interest   in   terms   of   demand   and 


THE  ABSTINENCE  THEORY  61 

supply  leads  to  some  ambiguities  in  regard  to 
the  meaning  of  the  word  supply.  In  like  manner 
it  forces  us  to  employ  the  term  "demand"  in 
a  somewhat  metaphorical  sense  in  the  case  of 
the  entrepreneur  who  saves  and  uses  his  own 
capital.  Can  such  capital  be  described  as 
supplied  in  response  to  a  demand  except  by 
twisting  the  meaning  of  the  language?  Who 
makes  the  demand? 

Of  course  these  objections  to  the  modern 
form  of  the  abstinence  theory  are  largely  formal, 
striking  at  defects  and  ambiguities  of  state- 
ment and  the  awkwardly  hypothetical  character 
of  its  propositions,  but  not  calling  into  question 
the  possibly  large  measure  of  truth  it  may  con- 
tain. The  pedagogic  rather  than  the  scientific 
value  of  the  theory  is  impugned.  Yet  in  spite 
of  the  risk  of  a  strained  form  of  statement 
distorting  the  perspective  and  throwing  minor 
factors  into  misleading  prominence,  it  would 
probably  be  maintained  by  many  writers  that 
the  demand  and  supply  formulation  of  the 
theory  of  interest  is  the  most  practicable  and 
compact  form  of  expression  possible.  The 
pertinent  question  is,  Does  it  give  an  approxi- 
mately true  description  of  the  factors  at  work? 
More  cannot  be  expected  from  any  theory  and 
unreasonable  demands  must  not  be  made  of 
the  theorist. 

There  are,  however,  objections  of  a  more 
material  character  which  may  be  made  to  the 


62  PROFIT  AND  WAGES 

abstinence  theory.  It  involves  two  funda- 
mental propositions  which  analysis  will  call 
into  question.  These  are: 

First,  the  total  amount  of  capital  rises 
or  falls  with  a  rise  or  fall  of  the  rate  of 
profit   (or  interest).     In  this  manner  the 
rate  of  return  to  capital  is  regulated  and 
kept  from  extreme  fluctuations.     A  corol- 
lary indicates  that  the  rate  cannot  fall  to 
zero  and  the  theory  thus  appears  to  account 
for  the  necessity  and  continuance  of  interest 
on  capital  as  well  as  for  its  rate  and  amount. 
Second,   the  changes  in  the  amount  of 
capital  which  are  regulative  of  the  rate  of 
return    are    brought    about    through    the 
operations  of  the  marginal  savers. 
Granting    for    the   moment    the    substantial 
truth  of  the  first  proposition,  although  we  shall 
see  later  that  it  is  not   always  valid,   let  us 
examine    the    second.      The    validity    of    this 
proposition  is  vital  to  the  abstinence  theory. 
If  changes  in  the  "supply"  of  capital  regulative 
of  the  rate  of  return  on  capital  are  not  deter- 
mined   primarily   by    the    course    of   marginal 
saving,  of  saving  determined  by  mental  states 
affected  by  the  expected  rate  of  return,  then 
the  decisive  factors  must  lie  on  the  side   of 
"demand,"  or  in  any  case,  be  of  an  objective 
rather  than  of  a  subjective  character. 

Now,  to  begin  with,  are  marginal  savings 
relatively  of  sufficient  amount  to  have  a  decisive 
influence  on  the  rate  of  profit  and  interest? 


THE  ABSTINENCE  THEORY  63 

Does  the  tail  wag  the  dog?  There  is  to  be  sure, 
no  way  of  deciding  definitely  what  proportion 
of  the  world's  capital  owes  its  existence  and 
maintenance  to  the  marginal  saver.  The  statis- 
tician may  seek  for  data  in  regard  to  the  sums 
which  are  saved  and  invested,  but  there  is  no 
numerical  record  of  the  mental  states  attending 
such  saving.  We  can  be  guided  only  by  our 
general  impressions.  To  the  present  writer 
it  appears  that  whatever  may  have  been  true 
in  some  communities  and  in  the  earlier  stages 
of  capitalism,  abstinential,  marginal  savings  are 
today  relatively  unimportant.  They  appear 
very  small  indeed  when  we  set  over  against  them 
—  (i)  the  large  accumulations  of  capital  made 
without  thought  by  recipients  of  large  incomes, 
the  unspent  residua  of  income  of  careless,  happy 
spenders;  such  accumulation  proceeding  at  a 
more  or  a  less  rapid  rate  according  as  the 
larger  incomes  rise  or  fall;  (2)  the  impersonal 
creation  of  capital  made  by  managers  of  cor- 
porations accumulating  surplus  out  of  earnings 
without  consulting  the  willingness  of  the  stock- 
holder to  abstain  from  consumption;  (3)  the 
stores  of  capital  amassed  in  the  past,  which, 
whatever  may  have  been  their  cost  of  abstinence 
in  the  saving,  are  now  maintained  inviolate 
from  all  thought  of  ever  being  consumed,  and 
incapable,  therefore,  of  decrease  except  through 
misfortune;  (4)  the  "rainy  day"  savings  which 
would  be  made  even  if  there  were  no  such 
thing  as  interest  or  profit  on  capital,  and  (5) 


64  PROFIT  AND  WAGES 

as  factors  diminishing  the  supply  of  capital, 
the  waste  and  destruction  of  capital  in  unpro- 
ductive, unfortunate,  or  fraudulent  enterprises; 
the  wreckage  of  promoter  and  speculator,  and 
the  wasteful  and  destructive  armaments  of 
military  nations. 

Moreover  whatever  be  our  estimate  of  the 
quantity  of  abstinential  saving  and  of  saving 
affected  at  all  by  the  contemplation  of  a  rate 
of  interest,  we  must  make  a  considerable 
deduction  for  that  portion  which  proceeds  in 
a  manner  directly  contrary  to  the  assumptions 
of  the  abstinence  theory.  To  some  who  experi- 
ence the  pangs  of  abstinence  a  fall  of  the  interest 
rate  is  the  occasion  for  saving  more  not  less, 
a  rise  the  occasion  for  saving  less.  "As  Sargant 
has  pointed  out,"  says  Marshall,  "if  a  man  has 
decided  to  go  on  working  and  saving  till  he  has 
provided  a  certain  income  for  his  old  age,  or 
for  his  family  after  death,  he  will  find  that  he 
has  to  save  more  if  the  rate  of  interest  is  low 
than  if  it  is  high."*  How  large  is  the  deduction 
we  must  make  for  saving  which  proceeds 
contrary  to  the  expectations  of  the  theory, 
there  is  no  way  of  estimating.  It  is  sufficient 
to  make  it  doubtful  what  the  effect  is  on  absti- 
nential, calculated  savings  taken  as  a  whole, 
of  any  change  in  the  rate  of  interest  and  profit. 
Three  hypotheses  may  be  suggested.  First, 
that  abstinential  savings  as  a  whole  rise  and 
fall  with  the  interest  rate,  moving  in  the  same 

^Principles  of  Economics,  6th  edition,  p.  235. 


THE  ABSTINENCE  THEORY  65 

direction.  Second,  that  they  move  in  the 
opposite  direction.  Third,  that  the  opposing 
tendencies  are  equal,  so  that  changes  in  the 
interest  rate  make  no  change  in  the  total  of 
abstinent ial  saving.  Only  the  first  of  these 
is  in  accord  with  the  necessities  of  the  abstinence 
theory.  But  are  we  justified  in  rejecting  the 
other  two  as  obviously  impossible?  And  in 
any  case  can  the  net  resultant  of  the  opposed 
tendencies  be  of  sufficient  amount  to  be  con- 
sidered an  important  factor  in  determining  the 
rate  of  return  on  capital?* 

*The  consideration  of  conscious,  deliberate,  and  calculating 
saving  alone  —  leaving  out  of  view  the  unconscious  and  imper- 
sonal forces  accumulating,  maintaining,  or  wasting  capital  — 
seems  likely  to  leave  one  in  doubt  as  to  the  exact  effect  of 
a  given  change  in  the  interest  rate.  Thus  Marshall  after 
giving  an  illustration  of  the  idea  we  have  quoted  from  him, 
proceeds:  "It  is  then  possible  that  a  continued  fall  in  the  rate 
of  interest  may  be  accompanied  by  a  continued  increase  in 
the  yearly  additions  to  the  world's  capital.  But  none  the  less 
is  it  true  that  a  fall  in  the  distant  benefits  to  be  got  by  a  given 
amount  of  working  and  waiting  for  the  future  does  tend  on 
the  whole  to  diminish  the  provision  which  people  make  for 
the  future  *  *  *  that  a  fall  in  the  rate  of  interest  tends 
to  check  the  accumulation  of  wealth."  Here  we  have  the 
traditional  view  of  the  effect  of  a  fall  in  the  interest  rate 
expressed  in  terms  of  tendency  and  "as  a  whole,"  while  the 
opposite  effect  is  allowed  as  "possible."  The  most  thorough 
discussion  of  the  mental  states  of  savers  is  probably  that  by 
Professor  Conner.  Conner  concludes  "alterations  in  the  rate 
operate  in  different  directions.  But  no  positive  and  universal 
determination  is  possible,  for  the  forces  are  irregular  and 
exist  in  no  fixed  relations.  It  is,  however,  clear  that  it  is 
incorrect  to  say  that  at  a  given  time  there  is  only  one  rate  of 
interest  able  to  bring  about  a  particular  amount  of  accumu- 
lation. On  the  contrary,  different  rates  may  bring  into  being 
the  same  amount  of  accumulated  wealth  and  capital."  Interest 
and  Saving,  p.  75  ff. 


66  PROFIT  AND  WAGES 

For  the  sake  of  argument  let  us  grant  the 
first  of  the  three  hypotheses.  Then  the  adherent 
of  the  abstinence  theory  is  confronted  with  the 
logical  necessity  of  showing  that  other  factors 
determining  supply  of  capital  act  in  the  same 
direction  as  the  marginal  savings,  in  their  total 
effect.  And,  furthermore,  if  the  abstinence 
theory  is  to  be  more  than  a  description  of  a 
very  minor  factor,  if  it  is  to  be  more  than  a 
fraction  of  a  complete  explanation,  it  becomes 
necessary  to  prove  that  the  action  of  the  various 
forces  determining  the  amount  of  capital  other 
than  the  marginal  savings,  must  be  determined 
by  the  latter.  In  other  words,  these  other 
forces  apparently  so  much  greater  in  their 
effect  than  the  operations  of  the  marginal 
saver,  must  be  shown  to  be  led  or  started  by 
the  marginal  saver  in  the  direction  in  which 
he  is  going. 

That  obviously  is  an  absurdity.  What, 
for  instance,  is  the  possible  relation  of  the 
marginal  saver's  worries,  to  the  large  quantities 
of  capital  supplied  by  those  who  cannot  be  said 
to  save,  for  that  connotes  some  thought  and 
purpose,  but  who  accumulate  large  sums  by 
failing  to  spend  all  they  receive?  Assume  a 
more  or  less  stable  standard  of  living  among 
those  whose  income  is  large  enough  to  make 
some  accumulation  of  capital  habitual  and 
continuous,  and  we  can  see  that  changes  in  the 
rate  of  accumulation  easily  follow  corresponding 
changes  in  the  volume  of  income.  There  is 


THE  ABSTINENCE  THEORY  67 

no  searching  of  heart  and  of  pocket-book  to 
see  whether  some  anticipated  though  uncertain 
percentage  offers  sufficient  reward  for  the  pangs 
of  abstinence.     It  may  be  that  there  is  some 
addition  to  or  substraction  from  the  world's  total 
of  capital  brought  about  by  the  contemplation 
of  the  movements   of  the  interest  rate,   but, 
in  any  case,  the  abstinence  theory  gives  an  ill 
proportioned   picture   of   what    actually   takes 
place  by  its  emphasis  on  savings  induced  by 
expectations  of  given  amounts  of  reward.     It 
carries  the  dubious  implication  that  more  or 
less  of  calculating  abstention  from  consumption 
makes  a  great  difference  and  that  the  prime 
factor  in  bringing  things  to  an  equilibrium  is 
a  mental  occupation  with  a  future  fact,  that  is, 
with  an  anticipated  rate  of  gain.     Is  it  not  a 
truer  view  to  regard  as  the  moving  factor  one 
that  belongs  to  the  past  rather  than  to  the 
future,  the  fact  of  increased  or  decreased  income? 
The  mainspring  of  the  great  movements  of 
the  supply  of  capital  cannot  be  found  in  the 
marginal   saver's   mind.     This   is   the   opinion 
forced  upon  us  when  we  consider  the  accumu- 
lations made  without  thought  and  effort  out 
of  large  incomes.     In  like  manner  we  fail  to 
find  any  discoverable  connection  between  painful 
abstinence    calculations    and    the    reservations 
for  surplus  made  out  of  the  earnings  of  large 
corporations  or  even  of  smaller  business  units. 
And  what  have  considerations  of  abstinence  to 
do  with  maintaining  in  the  face  of  any  fall  of 


68  PROFIT  AND  WAGES 

the  interest  rate  yet  experienced,  the  capital 
sums  once  saved?  What  pang  of  abstinence 
could  ordinarily  be  balanced  against  the  grief 
of  parting  with  capital?  And  finally  when  we 
come  to  the  various  forces  wasting  and  destroy- 
ing capital,  as  they  manifest  themselves  espe- 
cially in  times  of  crisis  and  of  war,  we  may 
confess  our  inability  to  give  a  full  explanation 
of  their  appearance,  and  yet  have  no  hesitation 
in  declaring  that  the  marginal  saver's  states 
of  mind  count  for  nothing  in  these  affairs. 

If  the  calculations  of  the  marginal  saver  are 
not  the  mainspring  of  the  great  forces  deter- 
mining the  amount  of  capital  in  the  world,  the 
abstinence  theory  fails  as  an  explanation  of 
the  quantity  and  rate  of  capitalist  income.  Our 
argument  has  led  to  the  conclusion  that  no 
simple,  easily  formulated  psychological  factor 
can  account  for  increase  or  decrease  of  capital. 
The  prime  factors  must  be  objective.  How 
large  is  the  product  of  industry  and  how  much 
of  it  is  left  after  wage  earners  and  other  recipients 
of  small  pay  have  drawn  their  share?  In  other 
words  what  is  the  income  in  the  shape  of  rent, 
interest,  and  profits  out  of  which  capital  is 
accumulated?  Out  of  which  it  may  almost  be 
said  to  accumulate  itself.  And  what  are  the 
factors  determining  the  waste  and  destruction 
of  capital,  the  only  factors  capable  of  causing  a 
positive  decrease  in  the  total  of  capital  and  not 
merely  a  slackening  in  the  rate  of  its  increase? 
Such  are  the  overwhelmingly  important  forces 


THE  ABSTINENCE  THEORY  69 

making  the  supply  of  capital  what  it  is.  They 
act  in  entire  independence  of  the  marginal 
saver's  supposed  balancing  of  the  cost  of  absti- 
nence against  the  attractions  of  an  anticipated 
reward.  They  are  objective  rather  than  sub- 
jective factors  and  will  not  fit  the  logical  neces- 
sities of  the  abstinence  theory.  And  it  may  be 
added,  they  are  equally  recalcitrant  to  the  needs 
of  the  time-preference  theory.  It  matters 
nothing  to  the  argument  whether  we  speak  of 
the  cost  of  abstinence  or  the  cost  of  waiting, 
the  reluctance  to  abstain  from  consuming  or 
the  reluctance  to  postpone  consumption.  The 
fact  is  that  no  unobjectionable  formulation  of 
the  process  we  are  trying  to  explain  is  possible 
in  terms  of  anything  psychological. 

It  appears  to  the  writer  that  sufficient  grounds 
have  been  given  for  rejecting  the  abstinence 
theory  and  its  possible  variants.  Some  con- 
sideration, however,  may  be  given  to  the 
question  whether  marginal  savings  move  with 
the  greater  forces  determining  supply  of  capital 
and  in  the  same  direction.  Or,  to  state  the 
question  with  a  different  emphasis,  do  the  great 
forces  other  than  the  marginal  saver's  operations, 
act  in  the  same  direction  in  response  to  changes 
in  the  rate  of  interest  and  profit  as  the  marginal 
savings,  assuming  the  latter  to  act  as  described 
by  the  abstinence  theory?  In  that  case,  although 
neither  of  these  two  sets  of  factors  determines 
the  other,  the  fact  of  their  being  more  or  less 
synchronous  and  parallel,  would  make  it  possible 


70  PROFIT  AND  WAGES 

to  maintain  that  the  abstinence  theory  describes 
a  part  of  the  forces  determining  supply  of  capital, 
though  a  very  small  part,  and  that  as  long  as 
we  care  only  for  the  direction  of  change  and 
not  for  the  amount,  the  abstinence  theory 
could  predict  correctly  what  will  happen  under 
given  conditions.  However,  not  even  that 
slight  concession  may  be  made  to  the  value  of 
the  theory.  It  isn't  true  that  the  decisive 
factors  always  and  necessarily  increase  or  de- 
crease the  total  of  capital  according  as  the  rate 
of  interest  and  profit  rises  or  falls.  These 
factors  may  at  times  act  in  that  manner,  and 
thus  prevent  large  fluctuations  in  the  rate 
of  return  on  capital,  but,  as  will  appear,  such 
is  not  their  invariable  action.  In  fact  it  is  not 
possible  to  formulate  any  "law"  or  simple 
general  proposition  in  regard  to  the  influence 
of  the  rate  of  interest  or  profit,  on  increase  or 
decrease  of  capital. 

Leaving  out  of  view  the  marginal  saver  and 
giving  attention  only  to  the  great  and  decisive 
factors  determining  supply  of  capital,  let  us 
ask  first  what  happens  when  the  rate  of  interest 
and  profit  goes  up.  Usually  we  may  expect 
an  increase  of  capital.  This  will  be  at  an 
accellerated  rate  if  the  rise  in  the  rate  of  interest 
and  profit  indicates  a  rise  of  the  total  of  interest 
and  profit;  if,  for  instance,  there  has  been  a 
great  advance  in  productive  efficiency,  or  in- 
creased opportunities  for  the  exploitation  of 
new  lands  or  cheap  labor.  In  that  event  there 


THE  ABSTINENCE  THEORY  71 

will  be  a  rapid  accumulation  of  capital  in  the 
shape  of  unspent  residua  of  income  and  large 
reservations  for  capital  use  out  of  gross  profits 
by  business  managers.  At  such  times  it  may 
almost  be  said  with  truth  that  the  opportunity 
for  large  gains  creates  the  capital  to  exploit 
the  opportunity.  A  less  rapid  growth  of  capital 
may  occur  when  the  higher  rate  of  interest  and 
profit  indicates  the  higher  productive  margin 
at  which  destructive  influences,  as  for  instance 
a  great  war,  have  left  the  diminished  total  of 
the  world's  capital.  In  spite  of  the  high  rates 
the  total  income  in  the  shape  of  interest  and 
profits  is  less  than  before  and  the  rate  of  growth 
of  the  total  capital,  will,  therefore,  probably 
be  less.  Whether  slowly  or  rapidly,  however, 
the  total  of  capital  may  be  expected  to  grow 
when  the  rate  of  return  goes  up.  And  yet  this 
is  not  the  inevitable  outcome  because  there 
may  come  into  play  the  forces  wasting  and 
destroying  capital,  forces  so  unpredictable  and 
erratic  as  to  have  the  appearance  of  extraneous 
and  accidental  factors  from  the  view  point  of 
economic  theory. 

If  the  movement  of  capital  in  response  to 
a  rising  rate  of  interest  and  profit  is,  on  the 
whole,  in  accord  with  that  assumed,  though  not 
correctly  explained,  by  traditional  economic 
thought,  the  same  cannot  be  said  of  the  results 
of  a  fall  of  the  rate  of  capitalist  gain.  If,  what 
is  the  most  probable  case,  the  fall  in  the  rate  of 
return  is  due  to  the  lowering  of  the  productive 


72  PROFIT  AND  WAGES 

margin  brought  about  by  the  increase  of  capital, 
the  total  of  income  in  the  shape  of  interest  and 
profit  has  been  increased.  New  supplies  of 
capital  seeking  investment  receive  only  a  low 
rate  but  the  recipients  of  interest,  profit,  and  rent, 
as  a  class,  are  wealthier  than  before.  The 
accumulation  of  new  capital  out  of  these  incomes 
might  therefore  be  expected  to  continue  in 
greater  rather  than  in  lesser  volume. 

The  case  of  a  lowered  rate  signifying  a  general 
decline  in  productive  efficiency  and,  therefore, 
a  decrease  of  the  total  of  incomes  in  the  shape 
of  interest  and  profit,  is  so  purely  hypothetical 
and  remote  from  our  experience,  that  it  seems 
hazardous  to  speculate  concerning  it.  Capital 
might  simply  show  a  decreased  rate  of  growth. 
There  would  probably  still  be  some  saving  for 
a  rainy  day.  And  even  if  the  total  of  capital 
did  not  increase  there  need  be  no  decrease. 
The  large  capital  accumulations  of  the  past 
might  be  jealously  guarded  against  the  desires 
of  spendthrift  and  consumer.  The  same  con- 
siderations probably  apply  to  the  case  of  a 
general  diminution  of  interest  and  profit  brought 
about  by  labor  gaining  a  larger  proportion  of 
the  total  product  of  industry.  In  fact  all 
conceivable  conditions  seem  to  include  some 
saving,  that  is,  some  addition  to  the  stock  of 
capital,  and  a  holding  on  to  what  has  once 
been  saved. 


THE  ABSTINENCE  THEORY  73 

Whatever  conditions  we  assume,  it  seems 
difficult  to  prove  any  probable,  positive  decrease 
in  the  total  of  the  world's  capital.  In  what 
appears  for  an  advanced  industrialism  the 
most  likely  cause  of  a  decline  in  the  rate  of 
capitalist  return,  that  is  the  lowering  of  the 
margin  of  investment  brought  about  by  the 
increase  of  capital  itself,  the  result  is  an  accel- 
erated increase  in  capital.  But  if  such  is  the  case, 
what  keeps  the  rising  tide  of  capital  from 
forcing  the  marginal  rate  of  profit  downwards 
until  it  vanishes  from  sight?  What  makes  the 
continuance  of  the  capitalistic  system  itself 
possible? 

Economists  apparently  have  not  given  much 
consideration  to  the  distressing  thought  of  a 
rate  of  profit  reduced  to  zero.  The  classical 
writers,  however,  frequently  raised  the  question 
as  to  what  agencies  resisted  the  strong  "tendency 
of  profits  to  a  minimum."  First  among  these, 
says  Mill,  is  "one  which  is  so  simple  and  so 
conspicuous,  that  some  political  economists, 
especially  M.  de  Sismondi  and  Dr.  Chalmers, 
have  attended  to  it  almost  to  the  exclusion  of 
all  others.  This  is  the  waste  of  capital  in 
periods  of  over-trading  and  rash  speculation, 
and  in  the  commercial  revulsions  by  which  such 
times  are  always  followed."*  To  "over-trading 
and  rash  speculation"  we  may  add  the  destruc- 
tion and  waste  of  capital  by  militarism.  The 
second  of  the  "counter-agencies"  according  to 

'Principles  of  Political  Economy,  Book  IV,  Chap.  IV. 


74  PROFIT  AND  WAGES 

Mill  is  "improvements  in  production."  So  far 
it  appears  that  capitalism  is  saved  by  waste  and 
progress.  A  third  factor,  mentioned  by  Mill, 
"the  perpetual  overflow  of  capital  into  colonies 
or  foreign  countries,"  indicates  that  the  day 
of  reckoning  may  be  postponed  by  the  extension 
of  capitalism  into  new  territory. 

Thus  either  by  the  destruction  of  the  super- 
fluity of  capital,  or  by  the  enlargement  of 
opportunities  for  investment  through  invention 
or  geographical  expansion,  the  rate  of  interest 
and  profit  is  kept  alive.  We  shall  not  undertake 
a  thorough  examination  of  the  extent  to  which 
the  fall  in  the  rate  of  capitalist  return  itself 
calls  out  these  counteracting  forces.  That  a 
low  rate  of  interest  stimulates  speculation  and 
unsafe  enterprises  is  fairly  obvious.  The  in- 
fluence of  the  over-accumulation  of  capital  on 
governmental  expenditures  and  imperialistic  pol- 
icies is  no  secret.  Of  the  restlessness  of  a  world 
forced  to  seek  an  ever  expanding  field  for 
investment  we  have  abundant  evidence.  The 
worry  of  our  age  has  been  its  redundant  capital. 

Our  discussion  has  shown  the  impossibility 
of  formulating  any  simple  general  law  in  regard 
to  the  response  of  capital  supply  to  a  changing 
rate  of  return.  There  is  no  definite  supply  price 
in  the  shape  of  a  rate  of  interest  for  any  given 
amount  of  capital.  On  the  whole  a  rise  in  the 
rate  of  return  tends  to  be  followed  quickly  by 
an  increased  supply.  On  the  other  hand,  a 
fall  in  the  rate  of  return  may  find  no  immediate 


THE  ABSTINENCE  THEORY  75 

check.  When  finally  checked  it  is  by  such 
forces  as  an  expansion  of  the  capitalistic  area, 
progress  and  invention  in  productive  methods, 
and  large  waste  and  destruction  of  capital. 

The  views  in  regard  to  the  supply  of  capital 
which  we  have  set  forth,  lack  the  attractive 
simplicity  of  the  abstinence  theory.  But  that 
simplicity,  like  the  excessive  rationalism  of  the 
time-preference  theory,  is  not  found  in  the 
actual  phenomena.  The  theory  supposes  a 
more  refined  and  persistently  followed  utilitarian 
calculus  than  seems  probable,  or  possible  to 
real  human  beings.  The  writer  does  not  deny, 
of  course,  that  there  may  be  serious  reflection 
on  the  question  of  spending  less  and  saving  more. 
To  a  rationalistic  view  the  utility  of  saving 
might  appear  to  be  increased  every  time  the 
interest  rate  moves  upward  a  little.  But  is 
the  problem  of  the  relative  attractions  of  saving 
and  spending  raised  in  anybody's  mind  every 
time  the  interest  rate  changes?  Are  not  such 
considerations  rather  occasional?  They  help 
to  establish  habits  of  spending  or  saving  a 
certain  amount.  Then  if  the  income  out  of 
which  saving  is  made  rises,  an  increased  "saving" 
takes  place  without  thought  of  what  rate  of 
interest  may  be  obtained  by  it. 

To  be  sure  it  is  conceivable  that  very  great 
and  sudden  changes  in  the  rate  of  return  might 
shake  people  out  of  their  established  habits 
into  deliberately  saving  more  or  less.  If  the 


76  PROFIT  AND  WAGES 

rate,  for  instance,  were  suddenly  to  jump  to 
twenty  per  centum,  saving  would  have  attrac- 
tions it  never  had  before.  A  sudden  drop  to- 
one-tenth  of  one  per  cent,  would  have  most 
disturbing  and  unpredictable  effects  on  those 
who  had  hitherto  been  in  the  habit  of  saving. 
But  do  changes  of  such  amount  as  experience 
teaches  us  to  expect,  lead  to  new  calculations 
of  how  much  we  may  save  or  spend  every 
time  they  occur?  When  the  rate  rises  from,  say 
four  per  cent,  to  four  and  a  fraction,  or  even 
to  five;  or  falls  from  four  to  three  and  a  fraction, 
or  even  to  three  per  cent,  how  many  are  there 
who  form  new  resolutions?  An  expected  return 
on  investment  of  some  kind  may  give  an  induce- 
ment to  saving,  a  support  to  the  habit  of  saving, 
-  for  some  persons,  a  general  reason  for  saving 
at  all.  But  that  does  not  mean  that  different 
definite  rates  of  prospective  return  directly 
determine  the  amount  of  saving  and  maintenance 
of  capital.  The  implication  of  the  abstinence 
theory  that  expected  rates  of  return  have 
this  definite  determinative  effect  is  an  unproved 
assumption.  But  even  if  the  painful  calculations 
of  some  marginal  savers  pursue  the  course 
described  by  the  exponents  of  the  abstinence 
theory,  are  they  of  sufficient  consequence  to 
make  any  real  difference?  Are  not  their  con- 
tributions to  the  current  supply  of  capital  so 
insignificant  compared  with  those  from  other 
sources,  that  a  general  theory  of  the  income  of 
capital  is  warranted  in  disregarding  them? 


THE  ABSTINENCE  THEORY  77 

The  great  factors  determining  the  supply  of 
capital,  we  may  call,  for  lack  of  a  better  term, 
objective,  in  contrast  with  the  subjective  deter- 
minants set  forth  by  the  abstinence  and  time- 
preference  theories.  Set  over  against  these 
objective  forces,  the  calculated,  abstinential 
savings  appear,  to  the  extent  of  their  tenuous 
being,  a  mere  epiphenomenon  of  our  modern 
industrial  system. 

If  the  view  just  presented  gives  a  substan- 
tially true  picture  of  what  takes  place  in  the 
existing  world  of  capital  accumulation  and 
investment,  it  follows  that  the  theory  of  the 
rate  of  interest  should  aim  first  to  account  for 
what  we  have  called  the  objective  factors. 
It  should  inquire  into  what  determines  the 
opportunities  of  a  gainful  use  of  different 
amounts  of  capital,  i.  e.,  it  should  give  us  first 
of  all  a  theory  of  the  origin  and  rate  of  profit. 
In  doing  this  it  will  be  well  to  avoid  metaphor 
and  not  to  speak  of  a  "demand"  for  capital. 
A  large  amount  of  capital  never  changes  hands 
and  there  is  no  question  as  to  who  is  to  use  it 
and  upon  what  terms.  It  is  neither  demanded 
nor  supplied.  It  is  merely  owned  and  used. 
When  the  rate  of  profit  has  been  accounted 
for,  theory  may  proceed  to  the  problem  of  the 
rate  of  interest,  the  problem  of  how  profit  is 
divided  between  capitalist  and  entrepreneur. 

The  more  fundamental  problem  of  the  rate 
of  profit  which  makes  possible  a  rate  of  interest, 
cannot  be  stated  satisfactorily  in  terms  of 


7  8  PROFIT  AND  WAGES 

demand  and  supply.  Theory  may  recognize 
that  the  amount  (not  the  supply)  of  capital  is 
a  determinant  of  the  rate  of  profit,  and  also 
that  saving  affects  that  amount  and  thereby 
the  rate  of  return.  But  saving  should  not  be 
put  forward  as  a  factor  acting  independently 
or  as  being  quantitatively  determined  by  factors 
independent  of  and  distinct  from  the  objective, 
technical  or  business  factors,  which  make  the 
rate  of  profit.  In  other  words,  saving  should 
not  be  represented  as  determined  by  subjective 
factors.  While  such  factors  may  affect  some 
saving,  the  decisive,  regulative  changes  in  the 
supply  of  capital  cannot  be  attributed  to  them. 
The  actions  and  purposes  which  determine 
conscious  saying,  the  calculations  of  abstinence, 
such  as  they  are,  cannot  be  co-ordinate  in 
importance  for  the  theory  of  profit,  with  the 
facts  which  determine  the  gains  of  capital. 
There  is  no  bargain  made  in  saving.  The 
saver  as  such  has  nothing  to  say  in  the  matter 
of  making  capital  yield  a  profit.  It  is  the  users 
of  capital,  their  skill  and  opportunities,  that 
really  signify.  The  usual  demand  and  supply 
formulation  of  the  abstinence  theory,  by  giving 
to  saving  and  abstinence  on  the  one  side,  an 
appearance  of  as  great  importance  as  that  of 
the  objective  factors  on  the  other,  gives  a 
misleading  perspective  to  all  the  factors  at 
work.  The  habit  of  thinking  in  terms  of  demand 
and  supply  has  its  drawbacks.  We  need  to 
break  away  from  the  see-saw  of  demand  and 


THE  ABSTINENCE  THEORY  79 

supply  to  reach  a  just  appreciation  of  the 
relative  importance  and  direction  of  the  forces 
which  make  the  existing  amount  and  rate  of 
capitalist  income. 

The  objection  to  the  abstinence  theory  coming 
especially  from  socialistic  quarters,  that  the 
large  capital  accumulations  of  the  rich  are 
subject  to  no  cost  of  abstinence,  was  apparently 
met  by  limiting  the  significance  of  abstinence 
to  the  marginal  saver.  But  this  answer,  we 
have  seen,  is  not  conclusive.  It  was  not  proved 
by  the  adherents  of  the  theory  that  abstinential 
savings  are  of  sufficient  amount  to  be  in  any 
way  regulative  of  the  rate  of  interest.  The 
capital  which  comes  without  abstinence,  with 
its  larger  volume  and  more  rapid  changes, 
leaves  the  tendencies  and  effects  of  abstinential 
savings  a  purely  secondary  movement,  of  imper- 
ceptible influence  on  the  actual  rate  of  capital- 
istic income.  We  need  not  look  to  the  abstinence 
theory  for  any  clear  light  on  the  problem  of 
the  amount  and  rate  of  interest  and  profit. 
It  fails  as  fully  as  the  time-preference  theory 
to  show  primarily  subjective  factors  as  the 
direct  determinants  of  the  rate  of  income. 

Our  criticism  of  the  abstinence  theory  has 
aimed  to  show  that  it  fails  to  account  for  the 
amount  and  rate  of  return  on  capital.  There  is 
the  further  question  as  to  why  there  is  interest 
at  all.  Why  is  it  possible  to  obtain  an  income 
without  labor?  Whether  an  answer  to  this 
question  entirely  satisfactory  to  all  students 


8o  PROFIT  AND  WAGES 

can  ever  be  given  seems  somewhat  doubtful. 
In  any  case,  among  the  data  necessary  to  an 
explanation  of  the  existence  of  the  institution 
of  interest  there  are  legal  and  historical  factors 
with  which  the  economic  theory  is  not  fitted  to 
cope.  Now  it  may  be  granted  to  the  abstinence 
theory  that  it  has  brought  to  light,  in  the  cost 
character  of  the  abstinence  necessary  to  some 
saving,  one  of  the  conditions  essential  to  the 
existence  of  interest.  If  saving  involved  no 
sacrifice,  the  volume  of  capital  would  rise  to 
the  point  of  making  interest  impossible.  Capital 
would  be  free  to  all.  But  if  it  should  cost 
nothing  to  save,  it  is  evident  that  income  must 
consist  of  "free  goods."  The  character  of  the 
abstinence  involved  in  saving  is,  therefore,  not 
only  one  of  the  conditions  of  the  appearance 
of  the  institution  of  interest  but  of  practically 
all  economic  life.  It  is  a  proposition  of  such 
general  character  that  it  seems  pedantic  to  cite 
it  at  all  instead  of  taking  it  for  granted.  How- 
ever, we  need  not  object  if  an  explanation  of 
the  existence  of  capitalist  income  should  take 
some  cognizance  of  the  fact  that  capital  depends 
on  saving,  and  that  because  our  income  consists 
of  "economic  goods"  and  not  of  "free  goods," 
saving  involves  abstinence.  But  if  we  seek 
an  explanation  of  the  existing  amount  of  capi- 
talist income,  the  consideration  of  abstinence 
and  in  general  of  subjective  factors,  is  of  slight 
advantage.  We  may  grant  too  that  the  con- 
cept of  abstinence  may  play  some  part  in 


THE  ABSTINENCE  THEORY  81 

capitalistic  apologetics.  With  that  however 
we  are  not  here  concerned.  The  obviously 
important  facts  for  the  purposes  of  the  theory 
we  are  seeking,  are  not  subjective  but  objective 
in  their  nature;  and  to  these  our  attention 
must  now  be  directed. 


CHAPTER  V 

THE  PRODUCTIVITY  THEORY  OF  INTEREST 

When  we  turn  to  the  study  of  the  objective 
factors  of  the  process  of  capitalistic  production 
and  distribution,  we  are  confronted  by  various 
attempts  to  deduce  interest  from  the  "produc- 
tivity of  capital."  These  productivity  theories 
differ  in  clearness  and  expository  detail,  in  the 
extent  and  manner  of  combination  with  other 
theories,  and  in  the  definition  of  capital  taken 
as  a  starting  point.  The  most  popular  form 
operates  with  a  conception  of  capital  as  a 
group  of  concrete  goods  used  as  instruments  of 
production.  With  such  instruments,  if  of  the 
right  kind,  labor  obviously  can  produce  more 
than  without.  This  excess  of  product  is  imputed 
in  more  or  less  metaphorical  language  to  the 
concrete  capital  goods,  and  the  assumption  is 
made  that  it  corresponds  in  some  way  with  the 
amount  of  income  that  the  capitalist  normally 
receives  from  the  use  of  his  capital. 

Two  problems  are  presented  by  this  form  of 
the  theory.  First,  how  can  the  part  due  to 
capital  in  the  joint  product  of  capital  and  labor 
be  marked  off  from  that  due  to  labor?  And 
secondly,  how  can  we  ascertain  what  part  of 
the  product  imputed  to  capital  is  to  be  regarded 
as  replacement  of  the  capital  used  up,  and  what 
as  net  remainder  may  be  stated  as  a  percentual 


THE  PRODUCTIVITY  THEORY  OF  INTEREST      83 

return  upon  that  capital?  Or  in  other  words, 
as  it  is  the  value  of  the  capital  itself  which  must 
be  deducted  from  the  part  of  the  product 
imputed  to  capital,  how  is  that  value  determined? 
To  determine  the  product  to  be  imputed  to 
capital  it  would  apparently  be  necessary  to 
know  what  labor  can  produce  without  capital. 
If  all  excess  of  product  above  this,  no  more  and 
no  less,  is  to  go  to  the  capitalist,  wages  would 
have  to  be  just  equal  to  what  the  labor  employed 
could  have  produced  without  the  aid  of  capital.* 
It  does  not  appear  to  be  easy  to  determine 
precisely  what  that  amount  would  be.  Nor 
does  this  determination  of  wages  appear  probable 
when  applied  to  certain  grades  of  labor.  It  is 
pretty  clear,  for  instance,  that  many  kinds  of 
skill  and  ability  would  be  of  very  little  use 
outside  of  capitalistic  industries.  If  it  were 
true  that  labor  gets  only  what  it  could  produce 
without  capital,  then  skilled  labor,  on  the  whole, 
would  receive  the  lowest  wages  paid  in  any 
industry.  It  would  be  inexpedient  to  take  up 
the  consideration  of  the  theory  of  wages  at  this 
point,  but  it  should  be  noted  that  the  inter- 
pretation of  the  productivity  theory  just  given 
suggests  a  view  of  wages  that  cannot  be  brought 
into  accord  with  any  of  the  theories  of  wages 
prevailing  at  present.  Moreover,  its  implication 
that  none  of  the  productive  advantages  of 

*To  avoid  complications  of  statement,  differential  profit  and 
rent  are  omitted  from  consideration  at  this  point  and  through- 
out our  discussion  of  capitalist  income.  The  problem  is  that 
of  the  division  of  marginal  product. 


84  PROFIT  AND  WAGES 

capitalism  go  to  the  wage-earner  would  not  be 
very  attractive  to  most  exponents  of  the  pro- 
ductivity theory. 

The  form  of  the  theory  now  most  in  favor, 
however,  does  not  clearly  impute  to  capital  the 
total  of  product  in  excess  of  what  labor  unaided 
by  capital  could  produce,  but  only  an  amount 
depending  on  a  rate  determined  by  the  pro- 
ductivity of  the  last  and  least  productive  unit 
of  capital  taken  on.  This  "marginal"  rate 
forced  upon  the  entire  amount  of  capital  leaves 
that  part  of  the  product  of  the  earlier  incre- 
ments which  is  in  excess  of  this  rate,  as  something 
that  does  not  go  to  the  capitalist  but  to  some 
other  "claimant"  in  the  distributive  process  — 
to  the  landowner,  or  to  the  entrepreneur,  or 
to  the  laborer.  This  method  of  calculating 
imputed  returns  is  also  applied  to  labor.  Alter- 
nately injecting  now  a  "dose"  of  capital,  now 
of  labor,  we  are  asked  to  observe  the  productive 
effect  of  each  to  get  its  "specific  productivity" 
and  rate  of  payment.  It  is  to  be  noted  that 
the  dose  must  be  a  homeopathic  one.  A  large 
increment  of  either  factor  would  necessarily 
call  for  a  simultaneous  increase  in  the  other. 
In  that  case  the  additional  product  obtained 
would  be  a  joint  product  of  capital  and  labor, 
not  a  "specific"  product  of  either,  and  there 
would  be  no  way  of  ascertaining  what  pro- 
portion of  it  should  be  imputed  to  each.  This 


THE  PRODUCTIVITY  THEORY  OF  INTEREST      85 

gives  an  air  of  extreme  unreality  to  the  theory 
in  question.  Is  the  calculus  of  small  doses  a 
possibility  in  the  conduct  of  actual  business? 

Granting,  however,  for  the  sake  of  argument, 
that  in  some  way,  the  return  to  be  attributed 
to  capital  can  be  calculated,  the  popular  specific 
productivity  theory  is  next  confronted  with 
the  difficulty  of  the  second  problem  mentioned 
above,  the  problem  of  determining  the  value 
of  the  capital.  Critics  of  the  theory  have  shown 
conclusively  that  it  fails  at  this  point.  How 
can  you  compare  the  product  with  the  capital 
to  which  it  is  imputed  in  such  manner  as  to 
ascertain  a  percentual  rate  of  return?  The 
goods  produced  and  the  "capital"  that  "pro- 
duced" them  are  of  unlike  physical  character 
and,  therefore,  incommensurable.  How  can 
you  express  yards  of  textiles  as  a  percentage 
of  the  looms  from  which  they  have  issued? 
Physical  measurements  give  no  basis  of  com- 
parison. Evidently  we  must  resort  to  market 
values.  If  we  ask  how  the  capital  good  gets 
its  market  value,  we  are  told  by  modern  econo- 
mists that  it  is  derived  from  its  product.  But 
why  is  not  the  value  of  the  capital  good  equal 
to  its  entire  product?  Why  is  there  in  the 
value  of  the  product  a  surplus  called  interest? 
Because,  for  some  reason,  the  entrepreneur 
will  not  pay  for  the  capital  good  more  than  the 
discounted  value  of  its  products.  It  appears, 
therefore,  that  the  discount  and  interest  rate, 
which  the  productivity  theory  represents  as 


86  PROFIT  AND  WAGES 

arising  from  a  comparison  of  values,  is  assumed 
in  getting  the  value  of  one  of  the  terms  of  the 
comparison,  —  an  obvious  case  of  circular  rea- 
soning. This  objection  to  the  popular  form  of 
productivity  theory  is  a  logical  inference  from 
a  theory  of  value  that  regards  demand  based 
on  estimates  of  utility  on  the  part  of  buyers, 
as  the  chief,  or  one  of  the  chief,  determinants 
of  value.  It  is  hard  to  see  how  those  who  hold 
the  Austrian  theory  of  value  can  accept  a  pro- 
ductivity theory  of  interest  while  denning  capital 
as  concrete  goods  used  as  instruments  of  pro- 
duction. 

If  instead  of  looking  forward  to  the  product 
for  the  source  of  the  value  of  the  capital  good, 
it  be  permissible  to  look  backward  to  its  expenses 
of  production,  a  productivity  theory  based  on 
the  concept  of  capital  as  consisting  of  concrete 
goods,  would  still  be  exposed  to  the  criticism 
that  it  is  reasoning  in  a  circle.  A  view  of  the 
entire  process  of  production  shows  the  invest- 
ment of  capitalists  and  entrepreneurs,  as  a  class, 
to  consist  of  advances  to  labor.  If  we  might 
assume  these  advances,  that  is  wages,  deter- 
mined in  some  way  independently  of  the  product 
of  capitalistic  industry  (by  the  "cost"  of  labor, 
for  instance)  we  should  get  a  value  for  capital 
with  which  the  net  product  might  be  legitimately 
compared  in  calculating  the  percentual  rate 
of  return.  But  the  theory  we  are  considering 
confines  the  term  capital  to  concrete  goods  used 
in  the  later  stages  of  production.  The  price 


THE  PRODUCTIVITY  THEORY  OF  INTEREST     87 

of  these  goods  includes  not  only  payment  for  the 
labor  employed  in  making  them,  including  the 
labor  of  all  the  preparatory  stages,  but  also 
accumulated  interest  and  profit.  Obviously 
it  is  not  possible  to  get  the  value  of  the  capital 
good  without  assuming  a  rate  of  income  upon 
capital.  Whatever  method  this  theory  takes 
of  accounting  for  the  value  of  capital  goods, 
involves  it  in  a  vicious  circle. 

We  might  therefore  regard  the  theory  we  have 
just  considered  as  disposed  of,  and  pass  on  to 
other  variants  of  the  productivity  theory.  It 
is  desirable,  however,  to  point  out  some  diffi- 
culties arising  from  the  restricted  concept  of 
capital  employed  by  this  theory.  Obviously 
the  entrepreneur  expects  to  gain  at  least  the 
rate  of  interest  from  all  of  his  business  outlays, 
not  merely  from  what  he  spends  for  "capital 
goods,"  but  also  from  his  expenditures  for  labor. 
The  exponents  of  the  specific  productivity  theory 
say  nothing  about  the  interest  earned  by  the 
employer's  pay  roll.  Yet  the  fact  of  this 
interest  cannot  be  denied.  Or,  is  it  an  illusory 
phenomenon?  Could  it  be  argued  that  all 
interest  grows  out  of  capital  goods  alone  but 
that  it  is  spread  as  a  uniform  rate  over  the  entire 
investment  of  capitalist  and  entrepreneur?  If 
this  were  the  case,  the  actual  rate  known  to 
business  men  would  be  smaller  than  the  rate 
of  productivity  of  the  capital  goods,  and  the 
productivity  theory,  while  indicating  the  source 
of  interest,  would  stand  in  need  of  further 


88  PROFIT  AND  WAGES 

development  to  explain  how  the  actual  rate  of 
interest  is  established.  The  problem  confronting 
the  productivity  theorists  would  be  the  inverse 
of  that  met  by  Karl  Marx.  To  obtain  the  rate 
of  profit  Marx  had  to  show  how  the  surplus 
value  due  only  to  " variable  capital,"  i.  e.,  to 
what  is  paid  for  labor,  is  assigned  to  and  ex- 
pressed as  a  percentage  of,  the  total  investment, 
of  both  "constant"  and  variable  capital.  The 
productivity  theorist  would  have  to  meet  the 
problem  of  spreading  a  surplus  from  the  use 
of  the  "constant"  capital,  the  concrete  capital 
goods,  over  the  entire  capital,  variable  and 
constant.  Unlike  Marx  they  have  made  no 
effort  to  solve  their  problem. 

Or  may  interest  on  the  wages  fund  be  regarded 
as  a  derivative  income?  Could  it  be  argued, 
in  a  manner  analogous  to  the  reasoning  of  the 
fructification  theory,  that,  because  the  capitalist 
can  obtain  interest  from  capital  goods,  he  will 
refuse  to  buy  labor  except  at  a  discount  which 
will  yield  him  the  same  rate  of  interest?  But 
capital  goods  have  no  productive  value  unless 
served  by  labor  and  the  entrepreneur  could  not 
refuse  to  buy  labor  and  turn  entirely  to  capital 
goods.  If,  under  such  conditions,  labor  submits 
to  a  discount,  that  fact  needs  to  be  explained. 
The  productivity  theory  suggests  no  explanation. 

Such  are  some  of  the  difficulties  of  the  form 
of  the  productivity  theory  which  we  have  been 
considering.  They  arise  out  of  the  restricted 
conception  of  capital.  The  usage  of  the  business 


THE  PRODUCTIVITY  THEORY  OF   INTEREST     89 

world  is  to  regard  all  outlays  whether  for  labor 
or  for  "capital  goods,"  as  an  investment  of 
capital  and  to  expect  or  hope  for  a  return  in 
profit  or  interest  on  every  part  of  the  invest- 
ment. In  taking  capital  in  the  sense  of  concrete 
instruments  of  production,  the  theory  fails  to 
take  account  of  important  interest-yielding 
investments.  Moreover,  this  restricted  con- 
cept of  capital,  limits  the  view  to  one  segment 
of  the  long  process  of  capitalistic  production. 
It  has  nothing  to  say  about  the  labor  that  made 
the  "capital  good,"  the  machine,  for  instance, 
nor  the  conditions  under  which  that  labor  was 
employed.  It  does  not  go  back  to  the  beginning 
of  the  productive  process,  but  fixes  attention 
on  one  of  the  later  stages  in  asking  what  is 
added  to  total  product  by  the  use  of  a  given 
capital  good.  It  proceeds,  in  the  language 
of  Bohm-Bawerk,  as  if  the  capital  had  dropped 
from  heaven.  A  theory  operating  with  such 
a  restricted  concept  of  capital  must  be  expected 
to  come  to  grief. 

But  now  we  may  inquire  whether  taking 
into  consideration  every  class  of  investment 
directly  connected  with  productive  industry, 
and  viewing  the  process  of  production  as  a 
whole  and  not  by  detached  portions,  a  pro- 
ductivity theory  may  be  constructed  that  can 
escape  the  pitfalls  in  the  way  of  the  ordinary 
productivity  theory  and  meet  the  demands 
that  must  be  made  upon  a  complete  theory. 


90  PROFIT  AND  WAGES 

If  we  view  the  productive  process  as  a  whole, 
it  appears  that  we  have  nothing  before  us  but 
human  labor  acting  upon  the  physical  world. 
There  is  no  capital  as  a  distinct  productive 
factor.  The  investment  of  the  capitalist  and 
entrepreneur,  the  "use  of  capital"  regarded 
from  the  point  of  view  of  production,  is  nothing 
but  a  special  way  of  applying  labor  —  the 
"round-about,"  indirect,  capitalistic  way.  And 
while  nothing  but  labor  is  used,  nothing  is 
paid  out  by  the  entrepreneur  in  his  business, 
nothing  is  "invested,"  that  is  not  looked  upon 
as  capital.  If,  however,  we  regard  the  entire 
process,  entrepreneurs  as  a  class  appear  to 
pay  out  nothing  but  wages.  It  is  only  between 
members  of  the  class  of  entrepreneurs,  between 
those  in  control  of  the  different  segments  of 
the  process  of  production  of  any  commodity, 
that  payments  are  made  for  anything  that  is 
not  labor.  The  purchase  and  sale  of  "inter- 
mediate goods"  necessary  in  making  the  con- 
sumable goods  which  are  the  ultimate  outcome 
of  an  extended  process,  is  a  purely  intra-class 
affair.  As  such  these  transactions  are  only  a 
method  of  dividing  up  the  investment  and  the 
gains  of  capital  in  an  extended  process.  In  a 
comprehensive  view  of  the  process  of  production, 
there  are,  therefore,  no  separate  outlays  for 
labor  and  for  capital.  How  then  can  one 
distinguish  a  "specific  product"  of  capital? 


THE  PRODUCTIVITY  THEORY  OF  INTEREST      91 

How  trace  any  such  connection  between  product 
and  the  return  of  capital  as  would  justify  us  in 
formulating  a  productivity  theory? 

In  the  attempt  to  make  out  a  productive 
return  in  some  way  imputable  to  capital,  one 
might  be  disposed  to  point  to  the  fact  that  the 
capitalistic,  indirect  method  of  applying  labor 
gives  a  larger  productive  result  than  the  non- 
capitalistic,  direct  use  of  labor.  This  is  not 
saying  merely  that  labor  with  tools  can  produce 
more  than  labor  without  tools.  It  means  that 
a  given  quantity  of  labor  will  yield  a  larger 
result  if  some  of  it  is  used  to  make  tools  than 
if  all  of  it  were  used  without  such  helps.  That 
the  productive  advantage  of  the  capitalistic 
process,  the  surplus  of  product  it  can  yield 
above  that  given  by  an  equal  amount  of  labor 
used  in  non-capitalistic  ways,  is  an  important 
source  (if  not  the  only  one)  of  the  income  of 
capitalist  and  entrepreneur,  is  a  statement 
not  likely  to  meet  with  contradiction.  Whether 
the  amount  of  this  surplus  can  be  definitely 
ascertained  or  not,  whether  all  of  it  goes  to 
capitalist  and  entrepreneur,  or  whether  the 
laborer  may  receive  a  portion  of  it,  whether 
capitalist  and  entrepreneur  are  restricted  to  it 
or  can  derive  gains  from  other  sources,  it  seems 
pretty  certain  that  such  a  large  part  of  the 
income  of  capital  is  drawn  from  this  surplus  of 
product,  that  if  there  were  no  such  surplus, 
capitalism  as  we  know  it,  could  not  exist. 


92  PROFIT  AND  WAGES 

The  recognition  of  the  superior  productive 
power  of  the  capitalistic  process  as  a  condition 
necessary  to  the  existence  of  profit  and  interest, 
does  not,  however,  give  us  a  complete  theory 
of  profit  and  interest.  There  remains  to  be 
explained  the  process  by  which  a  percentual 
rate  is  brought  about  and  of  course  the  explana- 
tion may  not  assume  this  rate.  The  time- 
preference  theory  would  account  for  the  rate 
by  an  appeal  to  subjective  factors.  The  pro- 
ductivity theory,  however,  or  any  theory  based 
on  objective  factors,  must  show  the  value  of 
the  investment,  the  "capital"  as  determined 
in  some  way  independently  of  the  discounted 
value  of  the  product.  Can  any  conceivable 
productivity  theory  meet  these  demands? 

At  this  point  we  need  to  consider  a  version 
of  the  theory  which  perhaps  may  come  to  be 
the  authoritative  one  for  many  who  hold  the 
faith.  It  is  suggested  by  some  passages  in 
Bohm-Bawerk's  writings  and  may  be  picked  out 
in  fairly  definite  form  from  the  eclectic  theory 
of  Landry.  Its  basis  is  not  the  productivity 
of  particular  concrete  capital  goods,  but  rather 
the  productive  advantage  of  an  extension  of 
the  "production  period,"  or  if  you  will,  the 
productive  advantage  of  a  longer  process  of 
production  as  compared  with  any  shorter  one. 
Successive  investments  taking  such  a  form  as 
to  result  in  extensions  of  the  production  period, 
bring  about  an  increase  of  return,  at  least 
within  certain  limits,  over  and  above  what 


THE  PRODUCTIVITY  THEORY  OF  INTEREST     93 

could  be  produced  in  a  shorter  process.  If  we 
may  suppose  different  methods  of  producing 
the  same  commodity,  some  more  capitalistic 
than  others,  or  to  put  it  in  other  words,  if  we 
suppose  productive  processes  of  different  length 
in  the  same  industry,  the  investment  necessary 
to  pass  from  the  less  to  the  more  capitalistic 
method,  from  the  shorter  to  the  longer  process, 
may  have  imputed  to  itself  the  increase  of 
product  realized.*  There  remains  to  be 
accounted  for  the  persistence  of  the  older  and 
less  capitalistic  methods,  the  relatively  under- 
equipped  establishments  existing  side  by  side 
with  the  superior.  There  is  to  be  explained 
the  failure  of  some  of  the  better  equipped  even, 
to  reach  the  maximum  of  efficient  equipment 
which  the  technical  knowledge  of  the  time 
seems  to  make  possible.  Why  does  not  the 
most  effective  form  and  degree  of  equipment 
known  become  general  throughout  each  industry? 
The  answer  given  is,  "Because  of  the  insuf- 
ficiency of  capital  available,"  capital  appearing 
to  mean  chiefly  the  means  of  supporting  labor, 
in  the  long  drawn  out,  capitalistic  processes 
of  production.  Because  of  this  lack  of  capital, 

*The  word  "method"  is  used  for  the  sake  of  brevity.  There 
need  not,  however,  be  a  distinct  difference  in  general  method. 
The  difference  thought  of  is  rather  in  the  degree  of  equipment 
with  some  of  the  results  of  the  earlier  stages  of  a  long  process, 
i.  e.,  it  is  a  difference  in  the  length  of  the  "production  period" 
as  measured  by  B6hm-Bawerk  (Positive  Theory,  Book  II, 
Chapter  II).  When,  however,  this  difference  reaches  a  certain 
degree,  it  becomes  difficult  to  think  of  it  as  only  quantitative 
and  not  as  a  qualitative  one,  i.  e.,  it  becomes  a  difference 
in  method. 


94  PROFIT  AND  WAGES 

there  remain  abundant  opportunities  for  gainful 
extensions  of  the  productive  process  and  the 
gains  must  fall  to  the  owners  of  capital. 

This  assumption  of  a  normal  insufficiency  of 
capital  is  somewhat  open  to  question.  It  is 
in  conflict  with  the  obvious  redundancy  of 
capital  which  appears  from  time  to  time.  If, 
indeed,  Bohm-Bawerk  were  right  in  thinking 
the  rate  of  product  capable  of  indefinite  increase 
through  lengthening  of  the  "production  period," 
there  never  could  be  capital  enough  to  exploit 
fully  the  endless  succession  of  productive  oppor- 
tunities. Bohm-Bawerk's  idea,  however,  we 
have  seen  is  erroneous.*  There  are  limits, 
perhaps  quickly  reached,  to  the  productive 
possibilities  of  employing  additional  capital 
in  extending  the  production  period.  In  conse- 
quence it  is  quite  conceivable  that  in  a  time 
of  rapid  increase  of  capital,  there  may  be,  not 
only  no  lack  of  capital,  but  an  excess.  The 
persistence  of  relatively  ill-equipped  establish- 
ments and  of  unexploited  opportunities  in  the 
face  of  such  abundance  of  capital,  can  be  ex- 
plained in  large  part  by  reference  to  factors 
which  economists  are  wont  to  group  under  the 
title  of  "friction."  Capital  is  not  a  perfect 
fluid  inevitably  finding  its  own  level  and  filling 
every  depression.  And  not  all  productive 
opportunities  are  controlled  by  men  of  sufficient 
ability  and  credit  to  command  all  the  capital 
which  might  be  advantageously  employed.  A 

*See  footnote,  page  24. 


THE  PRODUCTIVITY  THEORY  OF  INTEREST     95 

plethora  of  capital  may,  therefore,  obtain,  at 
least,  in  a  temporarily  static  or  unprogressive 
society.  In  a  dynamic  stage  of  industry, 
progressive  inventions  will,  for  a  time,  create 
opportunities  in  excess  of  what  the  capital 
available  can  exploit;  although,  as  we  have 
seen  in  the  preceding  chapter,  the  opportunity 
for  large  capitalistic  gains  may  rapidly  create 
the  necessary  supply  of  capital.  A  dynamic 
state  appears,  therefore,  to  be  a  necessary 
assumption  of  the  productivity  theory  which 
we  are  at  present  considering.*  It  is  not  a 
theory  applicable  to  static  conditions. 

The  formulation  of  the  productivity  theory 
we  are  considering,  has  some  points  of  super- 
iority over  that  which  operates  with  the  notion 

*This  suggests  the  theory  recently  advanced  by  Schumpeter, 
some  comment  on  which  may  be  introduced  at  this  point. 
Accepting  Clark's  argument  that  in  a  static  state  there  is  no 
"waiting,"  and  that  the  agio  theory  is,  therefore,  inapplicable; 
accepting  also  Bohm-Bawerk's  refutation  of  the  specific 
productivity  theory  of  interest  and  of  the  abstinence  theory, 
Schumpeter  concludes  that  interest  on  capital  in  a  static 
society  is  inexplicable  and  hence  impossible,  and  that  the 
explanation  of  the  appearance  of  interest  must  be  sought  in 
dynamic  factors.  To  the  present  writer  a  fundamental  defect 
in  Schumpeter's  views  is  found  in  his  theory  of  wages.  No 
static  society  such  as  Schumpeter  supposes  ever  existed  or 
could  exist,  but  if  it  is  permissible  to  the  imagination  to  con- 
struct such  a  state,  why  not  make  one  in  which  the  unchanging 
supply  of  capital  (acting  as  a  "wages  fund")  is  not  sufficient 
to  raise  wages  to  the  full  product  of  labor?  In  that  case  there 
would  be  interest  on  capital.  However,  the  concept  of  an 
entirely  static  state  is  full  of  pitfalls  and  had  best  be  avoided 
by  the  theorist.  It  is  frequently  necessary  to  think  of  a  par- 
ticular group  of  conditions  in  static  terms,  and  such  has  long 
been  the  practice  of  economists.  But  Schumpeter  is  wrong 
in  thinking  that  his  construction  of  a  complete  and  entirely 
static  state  is  a  logical  continuation  of  the  classical  tradition. 


96  PROFIT  AND  WAGES 

of  capital  as  consisting  of  instruments  of  pro- 
duction. In  its  use  of  concepts  made  familiar 
by  Bohm-Bawerk  it  presents  a  view  of  the 
productive  process  as  a  whole  instead  of  viewing 
it  by  segments.  But  on  closer  examination  it 
appears  to  be  only  a  different  formulation  of 
the  theory  of  marginal  productivity.  An  exten- 
sion of  the  productive  process  means  that  a 
larger  proportion  of  the  total  labor  employed 
is  used  in  the  preparatory  process  of  making 
and  perfecting  instruments  of  production.  Labor 
in  the  later  stages  will  therefore  become  equipped 
with  more  instruments,  and  the  full  productive 
advantage,  the  greater  quantity  of  consumable 
goods,  resulting  from  this  rearrangement  of 
the  proportions  of  labor  employed  at  the 
different  stages  in  the  production  of  commodi- 
ties, will  not  appear  until  the  additional  instru- 
ments have  been  used.  Now  it  shows  a  better 
understanding  of  what  is  fundamental  to  attri- 
bute the  increase  of  product  to  the  investment 
making  possible  an  extension  of  the  production 
period,  rather  than  to  the  capital  goods  which 
are  the  results  of  this  investment.  But  it 
doesn't  after  all  give  us  an  essentially  different 
theory.  Like  the  more  familiar  formulations 
of  the  productivity  theory  this  version  also 
represents  the  rate  of  interest  as  determined 
by  the  gains  of  the  additional  or  marginal 
increments  of  investment.  And  like  them  it 
fails  to  give  a  satisfactory  answer  to  the  question 
as  to  what  determines  the  value  or  price  of 


THE  PRODUCTIVITY  THEORY  OF  INTEREST     97 

what  is  invested.  Assuming  the  value  of  labor, 
like  that  of  other  production  goods,  to  be  the 
discounted  value  of  its  product,  it  assumes 
what  it  should  explain.  Viewing  the  productive 
process  as  a  whole  it  suggests  that  the  only 
investment  made  by  capitalists  as  a  class  is 
what  is  advanced  to  labor  in  the  form  of  wages.* 
Now  if  wages,  the  price  of  labor,  could  be 
shown  to  be  determined  independently  of  the 
discounted  product  of  labor,  the  way  would  be 
open  to  demonstrating  an  income  as  a  percentual 
rate  of  interest  upon  an  independently  deter- 
mined capital  value.  This  way,  however,  is 
closed  to  the  productivity  theorists  by  the 
theory  of  wages  held  by  them. 

It  does  not  appear  that  any  form  of  produc- 
tivity theory  has  as  yet  been  able  to  account 
in  a  satisfactory  way  for  the  rate  of  interest. 
Yet  there  must  be  some  truth,  or  something 
exercising  the  attraction  of  truth,  at  the  bottom 

*Bohm-Bawerk  includes  "uses  of  land"  (Bodennutzungen). 
There  is  no  "price  of  the  uses  of  land,"  that  is  no  rent,  at  the 
margin,  and  following  our  plan  of  viewing  the  problem  as  that 
of  the  division  of  the  marginal  product  only,  we  might  dis- 
regard the  difficulties  which  would  arise  for  the  productivity 
theory  from  the  attempt  to  include  rent  in  the  investment. 
If  rent  is  paid  at  the  end  of  the  productive  process,  as  a  share 
of  the  product,  it  creates  no  difficulties  for  the  productivity 
theory.  If  paid  in  advance,  it  supposedly  equals  the  discounted 
value  of  the  product  assigned  to  it.  In  that  case  there  enters 
the  illegitimate  assumption  of  a  discount  rate  already  estab- 
lished. It  may  be  remarked  in  this  connection  that  the  con- 
cept of  a  price  of  uses  of  land,  employed  by  Bohm-Bawerk 
and  Schumpeter,  is  an  unfortunate  substitution  for  the  older 
concept  of  land  rent.  It  conveys  the  misleading  suggestion 
that  different  quantities  of  uses  of  a  given  piece  of  land  may 
be  bought  at  a  given  point  of  time. 


98  PROFIT  AND  WAGES 

of  such  persistently  recurring  ideas  as  those 
formulated,  in  one  way  or  another,  in  the 
various  productivity  theories.  Capitalism  is 
more  productive  than  labor  not  aided  by 
capital.  To  the  writer  it  appears  that  the 
form  of  productivity  theory  we  have  just 
examined,  the  theory  suggested  by  Bohm- 
Bawerk  and  Landry,  has  some  elements  neces- 
sary to  a  complete  explanation  of  profit  and 
interest,  and  that  with  one  important  modifi- 
cation or  addition,  it  can  be  converted  into,  or 
led  over  into,  the  most  satisfactory  solution 
of  the  problem  at  present  attainable  by  the 
method  of  abstraction  and  general  theory. 
The  necessary  modification  is  to  be  reached  by 
the  way  of  a  theory  of  wages.  Before  pro- 
ceeding to  the  formulation  of  a  theory  of  profit 
and  interest,  it  will  be  well,  however,  to  call 
to  mind  just  what  is  the  nature  of  the  problem 
before  us. 


CHAPTER  VI 

THE    ESSENTIALS    OF    A    THEORY    OF    PROFIT    AND 
INTEREST 

To  make  income  appear  as  interest,*  it  must 
be  expressed  as  a  proportion  or  percentual 
rate.  Profit  of  capital  too  is  to  be  stated  as  a 
rate.  If  it  were  not  calculable  in  this  form, 
the  entrepreneur  would  not  know  what  to  bid 
in  his  bargain  with  the  capitalist,  and  the 
capitalist  would  be  ignorant  of  the  business 
value  of  what  he  had  to  offer.  The  existence 
of  a  rate,  however,  presupposes  two  values, 
(i)  the  income  that  is  calculated  as  a  rate 
and  (2)  the  capital  sum  of  which  the  income 
is  to  be  stated  as  a  percentage.  Let  the  rate 
be  represented  by  R,  the  net  income  by  I, 
the  capital  by  C.  Then 

I  =  CR 

This    equation    gives    us    three    quantities    of 
importance  in  the  theory  of  interest.    A  fourth 
significant    quantity,    the    gross    income,    rep- 
resented by  I',  is  given  in  the  equation 
I'-I+C 

Having  four  quantities  in  two  equations,  it 
will  suffice  to  know  two  of  the  four  in  order 
to  calculate  the  others.  The  theory  of  interest 
need  not,  therefore,  explain  the  quantitative 
determination  of  more  than  two  of  these  quan- 
tities. These,  however,  must  be  capable  of 
calculation  independently  of  the  other  two. 


ioo  PROFIT  AND  WAGES 

To  derive  them  by  assuming  one  or  both  of 
the  remaining  quantities,  and  then  to  turn 
about  and  use  them  in  accounting  for  the 
latter,  would  obviously  be  reasoning  in  a  circle. 

None  of  the  theories  so  far  examined  has 
explained,  or  appears  to  be  justified  in  assuming 
as  accounted  for,  more  than  one  quantity. 
That  quantity  is  I',  the  gross  income,  if  taken 
in  the  sense  of  the  product  in  the  shape  of 
consumable  goods  of  a  completed  process  of 
production.  Its  amount  is  explained  by  refer- 
ence to  the  technical  conditions  of  production 
and  its  value  by  the  demand  of  the  market. 
If,  however,  I'  is  to  include  the  product  of 
different  stages  of  the  process  of  production, 
-intermediate  or  producers'  goods,  as  well 
as  consumers'  goods,  —  it  cannot  be  accounted 
for  without  bringing  in  one  of  the  remaining 
three  quantities. 

The  productivity  theory  aims  to  explain  R 
by  showing  the  relation  between  C  and  either 
I  or  I'.  It  must,  therefore,  account  for  the 
value  of  C,  and  at  that  point,  as  critics  have 
shown,  the  theory  breaks  down. 

The  time-preference  and  abstinence  theories 
seek  the  origin  of  R  in  subjective  conditions. 
If  successful  in  this,  they  would  not  need  C 
or  I  to  account  for  R  but  could,  on  the  contrary, 
derive  C  and  I  from  the  R  which  they  have 
explained,  and  the  I'  which  they  might  legiti- 
mately assume  as  known.  If,  however,  the 
criticism  of  these  theories  presented  in  Chapters 


THE   ESSENTIALS  OF  A  THEORY  101 

III  and  IV  are  at  all  valid,  the  attempt  to 
derive  R  from,  subjective  factors  has  proved  a 
failure.  The  time-preference  view  is  false  to 
the  psychology  of  investment  and  the  abstinence 
theory,  while  suggesting  subjective  factors  which 
may  have  some  influence  on  investment,  fails 
to  prove  that  such  factors  give  a  definite  quan- 
titative result,  or  in  other  words,  that  they 
make  R  just  what  it  is. 

If  we  take  any  process  of  production  from 
beginning  to  end,  I',  its  product  in  the  shape 
of  consumers'  goods,  may  be  assumed  as  known 
and  accounted  for.  One  other  quantity  must 
be  found.  This  can  not  be  R.  The  productivity 
theory  makes  no  effort  to  show  an  independent 
origin  of  R;  the  time-preference  and  abstinence 
theories  have  failed  in  that  attempt.  It  must 
therefore  be  I  or  C.  No  way  has  yet  been 
suggested  of  accounting  for  I  without  using 
either  C  or  R.  The  theory  of  interest  must 
therefore  seek  to  show  the  quantitative  deter- 
mination of  C.  No  other  course  appears  to 
be  left  open. 

With  C  determined  as  well  as  I',  the  minimum 
of  data  needed  to  account  for  the  rate  of  profit 
and  interest  is  given.  But  C  must  be  deter- 
mined independently  of  I  and  R.  Furthermore, 
as  there  appears  to  be  no  way  of  deriving  C 
from  I'  except  by  a  not  permissible  introduction 
of  either  R  or  I,  we  may  say  that  it  is  a  necessity 
of  theory  to  account  for  C  without  resort  to 
I'.  Capital  (C)  as  quantitatively  determined 


102  PROFIT  AND  WAGES 

must  be  accounted  for  independently  of  the 
other  three  quantities  with  which  the  theory 
of  interest  and  profit  has  to  reckon. 

What  is  this  capital  (C)?  If  we  view  the 
production  of  any  kind  of  consumable  goods 
as  a  whole  and  disregard  its  segmentation  into 
particular  industries,  we  see  that  what  entre- 
preneurs and  capitalists  as  a  class  invest,  is 
just  wages,  nothing  more.  If  wages  as  C  can 
be  shown  to  be  determined  independently  of 
the  gross  income  (I')  of  industry,  then  I,  the 
net  return  to  capital,  can  be  obtained  by  sub- 
traction from  gross  income,  and  R  is  easily 

reckoned  by  the  formula  —  .    The  theory  of  in- 

\^s 

terest  as  we  have  seen  is  driven  to  account  for 
C  independently  of  the  product  of  industry  I' 
and  the  rate  of  interest  or  profit  (R).  If  capital 
is  restricted  to  so-called  "capital  goods"  this 
is  impossible.  The  value  of  a  machine,  for 
instance,  as  has  been  shown,  cannot  be  obtained 
without  assuming  a  rate  of  profit  and  interest. 
Nor  will  the  money  invested  serve  the  purposes 
of  theory.  It  is  not  money,  but  what  can  be 
bought  with  it  that  is  the  source  of  income. 
The  only  way  to  get  an  independently  deter- 
mined investment  upon  which  the  return  ob- 
tained can  be  calculated  as  a  rate,  is  to  view 
the  process  of  production  as  a  whole.  Then  it 
will  appear  that  the  investment  made  by  entre- 


THE  ESSENTIALS  OF  A  THEORY  103 

preneurs  and  capitalists  is  all  in  the  form  of 
wages.  C,  therefore,  consists  of  the  total  of 
wages. 

If  the  above  conclusion  in  regard  to  the 
direction  in  which  we  must  seek  for  a  solution 
of  the  problem  of  the  amount  and  rate  of 
income  on  capital  is  correct,  it  will  be  necessary 
to  find  an  explanation  of  wages  apart  from  the 
size  of  the  product  of  the  productive  process 
(I')  or  the  prevailing  rate  of  capitalist  return  (R). 
That,  however,  brings  us  into  conflict  with  the 
productivity  theory  of  wages,  which  in  one 
form  or  other,  commands  the  adherence  of 
most  economists. 

Now  the  theory  of  a  specific  product  of  labor, 
separable  from  the  specific  product  of  capital, 
and  determining  wages,  we  have  already  dis- 
posed of  by  implication  in  our  criticism  of  the 
specific  productivity  theory  of  interest.  It 
is  in  obvious  conflict  with  the  fact  that  the 
employer  regards  the  sums  paid  out  in  wages 
as  capital  on  which  he  must  earn  interest,  at 
least.  He  could  not  afford  to  pay  more  than 
the  discounted  value  of  the  product  to  the 
laborer.  The  widely  accepted  theory  of  wages 
as  determined  by  the  discounted  marginal 
product,  however,  stands  in  a  much  stronger 
position.  A  detailed  criticism  of  it  will  be 
given  in  Chapter  VIII.  This  form  of  the 
productivity  theory  has  the  advantage  of  not 
being  out  of  harmony  with  the  conception  of 
the  productive  process  gained  when  it  is  viewed 


104  PROFIT  AND  WAGES 

as  a  whole.  When  this  view  is  taken  it  appears 
very  clearly  that  we  are  driven  to  a  choice 
between  two  theories  of  residual  income.*  One 
theory  would  hold  the  rate  of  profit  to  be 
determined  by  subjective  factors,  by  calcula- 
tions of  the  cost  of  abstinence  or  waiting.  In 
that  case  the  wage  earner,  receiving  the  product 
of  labor  discounted,  is  the  residual  claimant. 
The  other  would  find  an  independent  explana- 
tion of  wages,  in  which  case  profit  of  capital 
can  be  accounted  for  as  residual  income.  The 
former  alternative  is  not  open  to  us  if  our 
criticism  of  the  time-preference  and  abstinence 
theories  is  valid.  There  remains,  therefore, 
only  the  residual  claimant  theory  of  profit. 

The  details  of  a  theory  of  wages  on  which 
this  view  of  profits  can  be  based  will  be  developed 
in  the  two  following  chapters.  The  remainder 
of  this  chapter  will  be  given  to  an  exposition 
of  the  theory  of  profits  we  have  reached  on  the 
assumption  that  the  theory  of  wages  necessary 
to  it  can  be  demonstrated.  Anticipating  a 
little,  however,  we  may  state  that  the  explana- 
tion of  wages  to  be  given  is  based,  in  part,  on 
the  idea  of  a  supply  price  of  labor  determined 
chiefly  by  conditions  outside  of  capitalistic 
industries  and  localities.  The  gains  of  capital 
are  largely  a  result  of  the  productive  superiority 

"Unless  with  the  "bargain  theory"  of  wages,  we  practically 
give  up  the  attempt  to  account  for  the  existing  division  of 
the  marginal  product  between  capital  and  labor,  and  declare 
it  to  be  simply  the  somewhat  indeterminate  outcome  o£  a 
struggle. 


THE  ESSENTIALS  OF  A  THEORY  105 

of  the  capitalistic  method.  By  using  expensive, 
"roundabout"  processes  and  methods  of  utilizing 
natural  forces,  not  accessible  to  the  laborer 
because  of  his  ignorance  and  poverty;  by 
organizing,  disciplining,  and  driving  laborers 
to  greater  effort  than  they  will  or  can  put  forth 
when  working  by  and  for  themselves,  —  capit- 
alistic industry  produces  a  surplus,  a  value  in 
excess  of  what  is  paid  out  in  wages.  The  wages 
paid  constitute  the  capital  invested,  if  we 
regard  industry  as  a  whole.  The  surplus 
product  is  profit  of  capital  plus  land  rent. 
Setting  aside  rent  and  differential  profit  as  the 
excess  income  of  investments  receiving  more 
than  the  marginal  return,  this  surplus,  as  profit 
of  capital,  can  be  stated  as  a  percentual  rate 
of  the  sum  paid  out  of  wages.  How  this  rate 
is  divided  between  capitalist  and  entrepreneur, 
establishing  a  rate  of  interest,  as  distinct  from 
this  rate  of  profit,  we  need  not  consider  at 
present.  It  is  not  a  problem  that  presents 
insuperable  difficulties.*  The  crucial  problem 
is  the  rate  of  profit. 

This  theory  of  profit  makes  the  productive 
advantage  of  the  capitalistic  process  appear 
as  an  important  source  of  profit  and  interest, 
yet  cannot  properly  be  called  a  productivity 
theory.  The  surplus  of  product  left  after  wages 
are  paid,  which  constitutes  profit,  while  largely 

*A   very   satisfactory   account   of  how   the   rate   of  interest   is 
established  can  be  found  in  Hadley's  Economics,  p.  269  ff. 


io6  PROFIT  AND  WAGES 

due  to  the  technological  advantage  of  using 
capital,  can  in  part  be  traced  to  other  sources. 
Some  of  it  is  due  to  the  knowledge  and  energy 
of  those  organizing  industry.  Some  also  to 
all  those  forces,  whether  operating  within  or 
without  the  sphere  of  capitalism,  which  make  a 
cheap  supply  of  labor  by  keeping  down  the 
standard  of  living  and  narrowing  the  economic 
opportunities  of  non-capitalistic  labor.*  Nor 
does  it  follow  that  the  entire  technological 
advantage  will  go  to  capitalist  and  entrepreneur, 
and  that  the  laborer  may  never  have  a  share 
in  it.  Some  of  the  surplus  may  be  used  to  lure 
labor  into  the  capitalistic  system.  Some  may 
go  to  labor  when  a  strong  union,  seizing  a 
temporary  advantage,  drives  a  hard  bargain. 
Some  goes  to  skilled  labor  which  has  been 
reared  within  capitalistic  districts  and  which 
outside  of  capitalistic  industries  could  look  for 
no  return  whatever. 

The  title  of  productivity  theory  would  not 
fit  the  views  here  set  forth.  Nor  would  the 
term  exploitation  theory  be  any  more  appro- 
priate, although  it  is  suggested  that  interest 
grows  out  of  a  portion  of  the  product  of  labor 
withheld  from  the  laborer.  The  term  exploita- 
tion carries  an  ethical  connotation  which  it 
would  have  been  well  to  keep  out  of  economic 

*Loria  and  Oppenheimer  have  especially  emphasized  conditions 
of  land  ownership  as  a  source  of  capitalistic  gain.  See  a  good 
summary  of  Loria's  writings  by  Rabbeno  in  Political  Science 
Quarterly,  Vol.  VII.  Of  Oppenheimer's  writings,  see  especially 
his  Theorie  der  reinen  und  politischen  Okonomie. 


THE  ESSENTIALS  OF  A  THEORY  107 

theory.  Whether  there  is  the  moral  wrong  of 
exploitation  at  the  source  of  capitalistic  income 
is  a  question  outside  of  the  scope  of  economic 
investigation.  It  is  not  probable  that  the 
purely  economic  theory  of  distribution  can 
contribute  more  than  a  small  part  of  the  data 
necessary  to  a  judgment  upon  the  present 
social  system  as  a  whole,  and  of  the  ethical 
status  of  the  income  of  capital  in  particular. 
We  are  taking  a  small  and  inadequate  view  of 
the  problem  raised  by  socialism,  if  hopes  or 
fears  of  settling  that  problem  give  any  bias 
to  our  thought  in  the  study  of  the  theory  of 
interest  and  profit. 

It  is  desirable,  therefore,  if  a  name  must  be 
given  to  the  theory  here  set  forth,  to  find  a 
term  without  ethical  flavor.  Such  a  safe, 
colorless  term,  one  properly  applicable,  is  that 
of  residual-claimant  theory.  It  is  the  name 
which  has  been  given  to  the  theory  of  profit  on 
capital  of  Ricardo  and  Marx,  with  which  our 
theory  is  in  substantial  agreement.* 

At  this  point  it  will  be  desirable  to  consider 
briefly  three  questions  suggestive  of  objections 
to  the  theory  here  advanced,  (i)  What  is 
there  to  prevent  excess  product  due  to  capital 

*See  Hollander  (The  Residual  Claimant  Theory  of  Distribution 
in  Quarterly  Journal  of  Economics,  February,  1903)  who  applies 
the  name  to  the  theory  of  Ricardo.  In  the  third  of  an  interest- 
ing series  of  articles  on  "Wertrechnung  und  Preisrechnung  im 
Marxschen  System,"  in  the  Archiv  fur  Sozialwissenschaft  1907, 
Bortkiewicz  suggests  the  name  Abzugstheorie  for  the  theory 
of  Ricardo  and  Marx. 


io8  PROFIT  AND  WAGES 

from  bringing  about  a  fall  of  values  which  would 
extinguish  profit  and  interest?  (2)  What  keeps 
labor  from  demanding  and  obtaining  all  that  it 
produces?  (3)  How  is  the  surplus  value  grow- 
ing out  of  a  series  of  processes,  under  the  control 
of  different  entrepreneurs,  distributed  as  a 
fairly  uniform  rate  to  every  part  of  the  invest- 
ment made  by  each  entrepreneur,  and  not 
alone  to  the  sums  paid  out  as  wages? 

To  take  up  the  first  question:  why  does  not 
the  surplus  value  including  profit  and  interest 
disappear  in  a  fall  of  prices?  How  can  the 
profit  be  kept  from  the  "consumer?"  There 
is  here  suggested  the  objection  sometimes  made 
to  the  productivity  theory  of  interest,  that  it 
does  not  show  how  the  capitalist  can  keep  his 
"product  of  capital"  from  lowering  prices  till 
interest  disappears.  This  apparent  difficulty 
is  by  some  writers  made  the  occasion  for  bringing 
in  the  cost  of  abstinence  as  a  necessary  check 
upon  redundancy  of  capital  and  capitalistic 
production.  The  objectors,  however,  fall  into 
the  common  error  of  thinking  of  but  one  industry 
at  a  time.  Excess  of  product  in  one  industry 
might  indeed  bring  about  a  "ruinous"  fall  in 
value.  A  general  fall  of  values,  however,  is 
impossible. 

Moreover  the  objection  that  profit  and  interest 
will  be  surrendered  to  the  "consumer"  unless 
production  is  in  some  way  limited,  rests  on  an 
erroneous  conception  of  the  status  of  the  con- 
sumer. When  we  look  at  things,  not  from  the 


THE  ESSENTIALS  OF  A  THEORY  109 

point  of  view  of  a  single  industry,  but  of  the 
industrial  system  as  a  whole,  it  is  obvious  that 
the  "consumers,"  the  purchasing  public,  are 
not  a  class  distinct  from  the  "producers,"  nor 
an  independent  factor  governing  prices.  The 
purchasers  or  consumers  are  the  capitalists 
and  laborers  of  the  productive  process.  As 
long  as  the  laborers  do  not  receive  the  whole 
sum  of  money  and  credit  possessed  by  capitalist 
and  entrepreneur,  as  long  as  the  latter  retain 
something  for  themselves,  this  something,  added 
to  the  purchasing  power  in  the  hands  of  the 
laboring  class,  will  keep  the  total  of  prices  of 
commodities  above  the  total  paid  out  as  wages. 
The  sum  of  prices  cannot  extinguish  profit  of 
capital  by  falling  to  the  sum  of  the  outlays  for 
wages.  As  long  as  the  capitalist  and  employer 
are  not  obliged  to  surrender  everything  to  the 
employe,  profit  and  interest  will  continue. 

But  may  profit  of  capital  throughout  industry 
as  a  whole  be  made  to  disappear  by  a  rise  of 
wages?  This  is  the  second  objection  our  theory 
must  meet.  Why  does  not  labor  obtain  the 
entire  product?  As  long  as  the  value  of  the 
product  is  in  excess  of  the  wages  paid,  would 
it  not  be  profitable  to  employ  additional  labor? 
Would  not  this  be  kept  up  until  in  every  industry 
wages  equalled  the  marginal  product,  leaving 
only  a  differential  profit  on  the  more  productive 
investment  but  no  profit  or  interest  at  the 
margin.  The  adherents  of  the  abstinence  or 
time-preference  theories  would  assert  that  the 


no  PROFIT  AND  WAGES 

needs  of  the  marginal  saver,  the  cost  of  his 
abstinence  or  waiting,  or  the  degree  of  his 
reluctance  to  give  up  present  for  future  goods, 
would  check  the  upward  course  of  wages. 
Do  these  subjective  factors  act  as  a  check  on 
any  forces  tending  to  narrow  the  rate  of  profit? 
And  if  they  do  not,  what  is  there  to  save  capit- 
alist income  from  extinction?  In  Chapter  IV 
it  has  been  shown  how  doubtful  and  uncertain 
is  the  influence  of  subjective  factors  in  checking 
the  fall  of  profit.  It  was  also  shown,  however, 
that,  when  additional  supplies  of  capital  meet 
a  vanishing  rate  of  return,  either  forces  destruc- 
tive of  redundant  capital  are  brought  into 
action,  or  new  opportunities  are  somehow  found 
for  profitable  exploitation.  Does  an  increasing 
supply  of  capital  have  a  tendency  to  raise 
wages?  Whether  it  does  or  not,  there  are 
forces  sufficient  to  check  an  increase  of  capital 
leading  up  to  an  extinction  of  profit,  —  forces 
so  erratic  in  their  operation,  however,  that 
it  is  impossible  to  predict  their  course  by  any 
simple  formula.  But  the  factors  determining 
the  scale  of  wages  form  the  subject  matter 
of  the  two  chapters  following  this.  A  full 
discussion  of  whether  they  could  threaten  profit 
with  extinction  would  be  out  of  place  at  this 
point. 

The  third  difficulty  which  must  be  met  by 
the  theory  here  advanced  is  that,  suggested  by 
the  question  as  to  how  the  surplus  product 
growing  out  of  a  series  of  processes  under  the 


THE  ESSENTIALS  OF  A  THEORY  in 

control  of  different  entrepreneurs,  is  distributed 
as  a  fairly  uniform  rate  and  assigned  to  each 
entrepreneur's  investment  and,  moreover,  to 
every  part  of  it  and  not  alone  to  the  sum  paid 
out  as  wages.  Apparently  a  rate  can  be  cal- 
culated only  by  the  summation  of  the  incomes 
of  all  the  capitalists  and  entrepreneurs  and  the 
estimation  of  this  sum  as  a  percentage  of  the 
total  paid  out  as  wages.  But  how  is  one  to 
proceed  from  this  rate  to  a  rate  assigned  to 
every  part  of  the  investment,  to  machinery  and 
buildings,  as  well  as  to  the  sums  paid  as  wages? 
As  a  matter  of  fact,  the  rate  of  total  profit  is 
purely  theoretical.  The  gain  to  capital  which 
arises  as  a  surplus  of  total  product  over  the 
total  of  wages  is  a  quantity  not  estimated  by 
any  one  as  a  percentual  rate.  It  is  a  quantity, 
however,  for  which  entrepreneurs  engage  in  a 
struggle  and  out  of  this  struggle  arises  an  average 
rate  of  profit  which  coincides  with  the  theoretical 
rate  of  total  profit. 

If  the  entire  process  of  making  any  given 
commodity,  including  the  production  of  all 
material  and  instruments  entering  into  the 
product,  or  used  up  in  the  process,  were  con- 
trolled by  one  entrepreneur,  —  whether  an  indi- 
vidual, a  partnership,  or  a  corporation,  —  it 
would  be  possible  to  state  total  returns  above 
wages  as  a  percentual  rate  upon  wages  regarded 
as  the  investment.  Actually  the  process  is 
divided  up  among  different  entrepreneurs,  and 
among  these  the  return  in  excess  of  wages,  is 


ii2  PROFIT  AND  WAGES 

divided  roughly  according  to  the  extent  of 
their  investment.  If  the  entrepreneurs  of  the 
earlier  stages  of  the  process  of  production  seek 
unusual  gains  at  the  expense  of  those  in  the 
later  stages,  the  latter  can  threaten  to  make 
themselves  independent  of  the  former  by  under- 
taking to  produce  for  themselves  the  materials 
and  instruments  they  may  need.  Or  they 
can  encourage  competitors  of  a  more  reasonable 
frame  of  mind.  In  like  manner  the  entrepreneurs 
of  the  earlier  stages  can  defend  themselves 
against  those  of  the  later.  Thus,  through 
bargaining  and  competition,  a  rate  of  profit 
becomes  established  for  any  given  industry. 
By  movements  of  capital  from  one  industry 
to  another,  the  rate  is  equalized  throughout 
the  industrial  system.*  This  equalized  or 
average  rate  of  profit  is,  of  course,  only  a 
theoretical  approximation  to  actual  conditions, 
a  static  goal  never  fully  attained  in  this  dynamic 
world.  The  sums  invested  are  given  a  share 
in  the  returns  according  to  the  time  at  which 
they  enter  the  investment.  In  other  words, 
the  rate  assigned  makes  allowance  for  the  time 
element,  and  is  calculated  and  compounded 
according  to  a  custom  established  before  modern 
capitalism  itself. 

The  solution  of  the  problem  of  profit  of  capital 
and  interest  given  above,  assumes  the  existence 
of  interest  and  capitalistic  calculation.  What 

*Compare  Ricardo,  Principles,  Chapter  IV,  and  Marx,  Kapital, 
Vol.  Ill,  especially  Chapter  X. 


THE  ESSENTIALS  OF  A  THEORY  113 

the  historical  origin  of  interest  may  have  been, 
how  such  an  income  was  possible  before  the 
modern  machinery  of  production,  and  why  it 
was  estimated  and  compounded  at  a  time  rate, 
are  questions  we  need  not  seek  to  answer. 
The  theory  aimed  at  in  all  of  the  foregoing 
discussion,  applies  to  the  modern  era  alone  and 
may,  therefore,  assume  as  given  such  factors 
as  have  been  transmitted  from  pre-capitalistic 
times.  As  long  as  the  method  of  "theory" 
takes  its  premises  from  conditions  now  open 
to  observation  and  not  from  the  historical  past, 
it  must,  of  necessity,  submit  to  such  limitations. 
It  reveals  the  forces  at  work  in  the  present  and 
the  conditions  of  their  continuance.  It  can 
make  no  pretense  of  throwing  light  on  the 
whole  course  of  the  evolution  of  economic 
institutions  whose  birth  has  preceded  our  his- 
torical era. 


CHAPTER  VII 

THE  THEORY  OF  WAGES.     THE  SUPPLY  OF    LABOR 

Our  discussion  of  the  income  of  capital  has 
led  of  necessity  to  the  question  as  to  what 
determines  wages.  The  marginal  product  of 
industry  is  divided  between  profit  and  wages. 
A  theory  of  either  of  these  shares  carries,  by 
implication  at  least,  a  definite  opinion  in  regard 
to  the  determinants  of  the  other.  The  view  of 
profit  and  interest  as  residual,  set  forth  in  the 
preceding  chapter,  rests  distinctly  on  the  assump- 
tion that  wages  are  determined  independently 
of  the  rate  of  profit  and  of  the  value  of  the 
product.  Obviously  the  next  step  in  our  argu- 
ment must  be  to  establish  a  theory  of  wages  in 
harmony  with  this  assumption.  Such  a  theory, 
however,  is  not  likely  to  meet  a  very  ready 
acceptance  unless  the,  at  present  widely  held, 
productivity  theory  of  wages  can  be  dislodged. 
A  criticism  of  this  theory  will  be  offered  in  the 
next  chapter.  In  passing,  however,  it  should 
be  pointed  out  that  because  of  the  close  relation 
between  profit  and  wages,  our  criticism  of  certain 
theories  of  interest,  if  valid,  has  by  implication 
given  a  refutation  of  the  productivity  theory 
of  wages  associated  with  these  theories.  If, 
for  instance,  there  is  no  specific  product  imput- 
able  to  capital,  separable  from  the  specific 
product  of  labor,  then  there  is  no  specific  product 


THE   SUPPLY  OF  LABOR  115 

of  labor.  Thus  the  weakness  of  the  specific 
productivity  theory  of  interest  is  also  the  weak- 
ness of  the  specific  productivity  theory  of  wages. 
Moreover,  the  impossibility  of  regarding  em- 
ployers as  willing  to  pay  out  sums  of  money 
for  wages  upon  which  they  do  not  earn  interest 
at  least;  in  other  words,  to  pay  the  full  undis- 
counted  product  of  labor  to  the  laborer,  — 
makes  the  specific  productivity  theory  appear 
too  obviously  inadequate  to  deserve  much 
attention. 

A  theory  much  in  fashion  to-day,  is  that  of 
wages  determined  by  the  discounted  marginal 
product,  the  rate  of  discount  being  fixed  by  the 
"rate  of  time-preference"  or  the  "cost  of  wait- 
ing." But,  if  we  have  succeeded  in  our  attempt 
to  show  that  time-preference  or  calculation  of 
the  cost  of  waiting,  or  postponement,  or  absti- 
nence, or  any  subjective  valuations  by  whatever 
name,  can  create  no  definite  rate  of  discount, 
then  obviously  wages  cannot  be  explained  as 
determined  by  discounting  the  product. 

In  the  view  of  profit  of  capital  as  a  residual 
claimant  set  forth  by  Ricardo  and  others,  the 
underlying  theory  is  that  of  wages  determined 
by  the  cost  of  subsistence  of  the  laborer.  If 
this  theory  of  wages  were  acceptable,  our 
argument  would  have  brought  us  to  the  Ri- 
cardian  view  of  distribution  in  most  of  its 
essential  positions.  Another  basis  for  a  theory 
of  profit  as  residual,  might  possibly  be  found 
in  the  bargain  theory  of  wages,  the  theory 


n6  PROFIT  AND  WAGES 

that  wages  are  the  outcome  of  a  contest,  of 
Machtverhaltnisse.  A  discussion  of  these  two 
theories  must  be  undertaken,  but  also  of  those 
in  obvious  conflict  with  the  theory  of  profit 
and  interest  for  which  we  are  contending. 
Following  the  course  of  historical  evolution  let 
us  begin  with  an  examination  of  the  subsistence 
theory. 

The  argument  for  this  theory  was  based  on 
Malthusian  views  in  regard  to  the  growth  of 
population.  If  wages  rose  above  the  "natural 
wage,"  earlier  marriages  and  a  higher  birth 
rate  increased  the  supply  of  laborers  and 
reduced  wages  to  the  old  level.  If  wages  fell 
below  the  natural  wage,  postponement  of  mar- 
riage and  a  lowered  birth  rate,  diminishing  the 
supply  of  labor,  raised  wages  again.* 

But  how  much  was  the  ' 'natural  wage?" 
It  was  supposed  to  give  the  laborer  a  living 
according  to  the  customary  standard  of  his 
class.  How  this  "standard  of  living"  originated, 
the  classical  enconomists  did  not  inquire.  It 
was  an  historical  problem  which  they  were 
under  no  necessity  of  solving.  All  that  was 
essential  to  their  argument  was  that  the  standard 
should  be  stable.  This  implied  that  in  times  of 
falling  wages,  the  standard  would  not  be  sac- 
rificed to  the  desire  for  marriage;  but  that  in 
times  of  rising  wages,  marriage  would  be  the 

*A  minor  factor  was  the  death  rate  varying  inversely  with 
changes  in  wages.  It  makes  no  difference  to  the  argument 
to  omit  its  action  from  consideration. 


THE   SUPPLY  OF  LABOR  117 

first  claimant  on  the  increased  income.  It 
supposed  a  great  fixity  in  the  manner  of  living 
of  the  working  classes  in  everything  except  the 
age  of  getting  married  and  the  consequent 
eventual  size  of  the  family. 

Now  if  the  term  "natural  wage"  was  to  have 
a  definite  meaning,  it  was  that  of  a  wage  suf- 
ficient to  maintain  at  the  customary  standard 
a  family  of  a  given  average  size.*  As  actual 
wages  departed  from  the  natural  wage,  the 
standard  of  comfort  was  maintained  by  a  varia- 
tion in  the  average  size  of  the  working  class 
family.  Thus  except  in  short  periods  of  transi- 
tion and  adjustment,  actual  wages  would  always 
cover  the  standard  of  living.  This  correspond- 
ence between  wages  and  the  standard  of  living 
could  not,  however,  be  regarded  as  evidence 
that  the  standard  effectively  determined  actual 
wages.  Unless  one  considered  results  in  the 
long  run,  the  truer  view  would  be  that  wages 
on  the  one  hand,  determined  primarily  by 
"demand,"  and  the  standard  of  living  on  the 
other,  had  no  effect  on  each  other,  but  together 
determined  the  average  size  of  workingmen's 
families.  To  express  the  same  thought  in 
a  different  manner,  the  standard  of  living 
maintained  itself  in  the  face  of  fluctuating 
wages  by  varying  the  average  size  of  families. 
If,  however,  one  looked  at  the  tendencies  of 
a  long  run,  it  would  appear  that  these  changes 

*To  be  very  precise,  a  given  average  size  and  composition,  as 
expenses  would  vary  somewhat  according  to  age  and  sex. 


n8  PROFIT  AND  WAGES 

in  the  average  size  of  the  family  would  eventually 
affect  the  supply  of  labor  and  thus  influence 
the  level  of  wages. 

It  should  be  noted,  however,  that  the  factor 
set  forth  by  the  classical  writers  as  regulating 
the  supply  of  labor  was  obviously  extremely 
slow  in  its  action.  It  might  take  fifteen  to 
twenty  years  for  a  sufficient  number  of  children 
to  be  born  and  trained  to  industrial  pursuits, 
to  increase  effectively  the  supply  of  labor;  or 
before  the  death  rate  overtaking  a  diminished 
birth  rate  could  effectively  decrease  the  supply. 
Because  of  this  slowness,  the  regulation  of  the 
supply  through  the  growth  or  decline  of  the 
laboring  population  would  bring  wages  back 
to  the  "natural  wage,"  only  if  disturbances 
of  the  actual  or  "market"  wage  through  fluctua- 
tions on  the  side  of  "demand"  did  not  occur 
except  at  long  intervals. 

But  is  there  a  natural  wage?  Ricardo  defined 
it  as  the  amount  necessary  to  enable  laborers 
"to  subsist  and  perpetuate  their  race,  without 
either  increase  or  diminution."  Now  the  en- 
tirely stationary  wage-earning  population  sup- 
posed by  Ricardo,  in  all  probability,  never 
existed.  And  if  population  has  always  either 
increased  or  decreased,  "natural"  wages  were 
never  paid.  The  concept  of  natural  wages, 
therefore,  could  at  best  serve  as  a  means  of 
exposition  only,  indicating  an  ideal  point  of 
equilibrium  towards  which  the  forces  making 
the  rate  of  wages  were  supposed  to  be  working. 


THE  SUPPLY  OF  LABOR  119 

The  slow  operation  of  the  factors  set  forth 
by  the  Malthusian  argument  for  the  subsistence 
theory,  forms  the  basis  of  Marx's  criticism  of 
this  argument.  Holding  that  there  is  a  decennial 
cycle  of  prosperity  and  crisis,  he  reasons  that 
long  before  a  rise  or  fall  of  wages  could  have 
any  effect  on  population  the  whole  scene  would 
be  shifted  by  various  phases  of  the  business 
cycle.*  As  an  objection  to  the  notion  that  a 
given  natural  wage  could  be  brought  about 
primarily  by  the  movements  of  population, 
Marx's  argument  has  great  force.  It  does  not, 
however,  dispose  of  the  fact  that  the  size  of 
the  working  population  has  an  effect  on  wages. 
Indeed,  the  further  development  of  Marx's 
own  ideas  on  wages  implies  such  an  effect. 
Nor  does  Marx  prove  that  wage  fluctuations 
are  of  such  disconcerting  frequency  that  the 
movement  of  population  cannot  at  all  be  affected 
by  a  rise  or  fall  of  wages. 

An  objection  to  the  Malthusian  argument 
for  the  theory  analogous  to  that  presented  by 
Marx,  is  suggested  by  the  part  which  immigra- 
tion plays  today  in  almost  all  the  great  industrial 
districts  of  the  world.  Against  the  vast  tide 
of  immigrants,  the  slow  changes  caused  by 
fluctuations  in  the  native  birth  rate  seem  of 
very  slight  significance.  It  should  be  remarked, 

*Das  Kapital,  Chapter  23,  Section  3. 


120  PROFIT  AND  WAGES 

however,  that  at  the  time  the  subsistence 
theory  gained  its  position  in  orthodox  political- 
economy,  this  difficulty  did  not  exist 

In  view  of  the  slowness  of  the  factors  described 
in  the  classical  exposition  of  the  subsistence 
theory,  there  was  obviously  the  need  of  a 
theory  of  wages  in  which  the  supply  of  labor 
should  be  regarded  as  practically  fixed  for  the 
time  being  —  a  theory  of  actual,  or  " market 
wages,"  as  distinct  from  the  "natural  wages" 
towards  which  things  tended  vaguely  in  the 
long  run.  In  such  a  theory  the  emphasis  would 
necessarily  be  on  "demand"  for  labor.  That 
the  subsistence  theory  was  not  a  complete 
explanation  of  the  rate  of  wages  was  clearly 
recognized  by  its  classical  exponents.  They 
supplemented  it  with  the  wages-fund  theory 
in  which  the  emphasis  was  placed  on  the  factor 
of  demand,  and  which  aimed  to  explain  market 
wages.  Thus  two  theories  were  held  simul- 
taneously. In  one,  the  wages  fund  theory, 
the  supply  of  labor  was  regarded  as  fixed  for 
the  time  being.  The  other,  the  subsistence 
theory,  we  have  seen  could  account  for  existing 
wages,  only  on  the  assumption  that  changes  in 
demand  occurred  at  long  intervals  only,  or 
in  other  words,  that  the  factor  of  demand  was 
fixed  for  long  periods  of  time. 

Now  it  might  appear  from  the  trend  of  our 
discussion  up  to  this  point,  that  our  chief  con- 
cern must  be  a  theory  of  "market  wages"  and 
of  the  factor  of  demand.  Though  recognizing 


THE   SUPPLY  OF  LABOR  121 

that  anything  affecting  the  birth  rate  would 
ultimately  influence  the  supply  of  labor,  and 
therefore,  affect  wages,  it  might  appear  that 
we  are  forced  to  consider  such  influences  so 
slow  in  their  operation  and  so  disturbed  by 
various  factors  of  more  rapid  movement,  that 
all  attempts  to  embody  them  in  a  general 
formulation  of  a  wage  theory  should  be  given 
up.  Why  not  rest  satisfied  with  a  theory  based 
on  the  assumption  of  population  as  fixed  for 
the  time  being?  It  will  appear,  however,  in 
the  further  progress  of  our  analysis,  that  we 
need  not  give  up  trying  to  make  some  definite 
statement  in  regard  to  the  factor  of  the  supply 
of  labor.  Indeed,  there  is  something  like  a 
definite  supply  price  of  labor,  as  important  in 
its  influence  on  wages  as  anything  on  the  side 
of  demand. 

But  let  us  return  to  the  subsistence  theory. 
The  greatest  obstacle  to  its  continued  and 
unquestioned  acceptance  appeared  when  it  was 
seen  that  the  standard  of  living  of  a  large  part 
of  the  industrial  population  was  rising.  If 
wages  had  gone  downward  instead  of  upward, 
the  standard  might  have  exhibited  greater 
fixity.  As  it  was,  the  idea  began  to  gain  ground 
that  the  standard  of  living  was  too  unstable 
to  be  regarded  as  a  regulator  of  wages.  The 
concept  of  a  natural  wage  vanished  into  thin 
air.  Even  the  more  modern  idea  of  supply 
prices  for  different  quantities  of  labor,  the  idea 
of  wages  acting  as  inducement  for  an  increased 


122  PROFIT  AND  WAGES 

or  decreased  supply  of  labor  as  they  rose  or 
fell,  became  untenable.  If,  for  instance,  a 
rise  of  wages  carried  the  standard  of  comfort 
upward,  its  ultimate  effect  might  be,  by  lowering 
the  birth  rate,  to  decrease  rather  than  to 
increase  the  working  population.  It  did  not 
appear,  however,  that  the  standard  is  so  in- 
stantly and  extremely  variable  that  there  is 
no  standard  at  all.  For  the  time  being  there 
is  a  standard,  though  possibly  a  short-lived  one. 
In  the  interval  before  the  change  to  a  different 
level,  the  standard  has  some  effect  on  the  birth 
rate  and,  therefore,  ultimately  on  the  supply  of 
labor  and  its  price.  But  if  it  affects  wages  it 
is  also  affected  by  them.  The  definite,  non- 
reciprocal  action  on  wages  assigned  to  it  by  the 
classical  school  is  not  perceptible. 

But  though  the  subsistence  theory  of  wages, 
based  on  the  Malthusian  argument,  became 
involved  in  all  these  difficulties,  it  does  not 
follow  that  it  was  never,  at  any  place,  a  valid 
explanation  of  the  facts.  Within  certain  geo- 
graphical and  historical  limits,  some  of  its 
reasoning  may  be  applicable.  On  the  back- 
ground of  modern  capitalism,  to  be  sure,  with 
its  large  fluctuations  of  employment,  its  pressing 
host  of  immigrants,  and  the  instability  of  all 
standards  of  comfort  and  discomfort,  the  Ricard- 
ian  doctrine  of  a  natural  wage  looks  like  some 
pale,  ancestral  shade.  But  it  was  from  a  different 
world  that  Malthus  gathered  the  evidence  for 
the  "principle  of  population"  which  was  made 


THE  SUPPLY  OF  LABOR  123 

the  basis  of  the  theory  of  natural  wages.  For 
most  of  the  people  of  the  eighteenth  century 
there  was  still  the  regular  routine  of  agricultural 
pursuits  calling  for  almost  the  same  number  of 
workers  year  after  year.  There  was  little 
immigrant  labor  and  the  manner  of  living, 
consecrated  by  custom,  was  almost  incapable 
of  variation.  In  the  backward,  rural  districts 
of  the  old  world  from  which  today  we  derive 
our  supply  of  unskilled  laborers,  we  'may  still 
see  conditions  differing  but  little  from  those 
pictured  by  Malthus.  To  be  sure  the  portentous 
fact  of  emigration  has  broken  into  the  quiet 
current  of  their  life.  The  established  standard 
of  living,  however,  still  possesses  stability. 
A  temporary  fall  of  income  results  in  emigration 
and  postponement  of  marriages,  a  rise,  in 
earlier  marriages  and  a  higher  birth  rate. 
New  commodities  enter  but  slowly  into  cus- 
tomary use.  The  luxuries  and  novelties  of  the 
well-to-do  are  both  geographically  and  socially 
too  remote  to  lure  to  a  more  expensive  scale 
of  living.  Of  course,  the  subsistence  theory 
may  not  be  applied  without  qualification  to 
an  explanation  of  the  income  of  the  laboring 
population  of  these  non-capitalistic  regions. 
As  already  indicated,  the  theory  cannot,  in  any 
case,  offer  a  complete  explanation  of  the  level 
of  wages.  If,  however,  we  had  only  these  old 
world  conditions  to  consider,  the  classical 


i24  PROFIT  AND  WAGES 

doctrine  of  wages  adjusted  to  cost  of  subsistence 
might  be  allowed  as  a  rough  approximation 
of  the  actual  forces  at  work. 

It  may  be  asked,  what  is  the  need  of  any 
reference  to  old  world  conditions?  Our  con- 
cern is  with  the  dividing  up  of  the  product  of 
capitalistic  industry  and,  therefore,  with  the 
wage  level  of  modern  industrial  centres  only. 
The  reply  to  be  given  is  that  it  is  a  mistake 
to  fix  the  attention  exclusively  upon  the  indus- 
trial areas  or  to  think  of  economic  life  as  all 
within  an  isolated,  national  unit.  The  con- 
ditions of  the  distant  sources  of  our  labor 
supply  cannot  be  without  influence  upon  indus- 
trial wages.  We  may  be  sure  that  an  important 
factor  determining  wages  in  all  growing  indus- 
trial centres  is  found  in  the  terms  upon  which 
additional  laborers  can  be  secured.  But  securing 
additional  laborers  means  attracting  increased 
immigration.  The  average  income  of  the  old 
world  population  from  which  our  unskilled 
laborers  are  almost  entirely  drawn  may  be 
said,  therefore,  to  constitute  part  of  the  supply 
price  of  labor  for  our  industries.  That  much, 
at  least,  must  be  paid  —  and  in  order  to  induce 
men  to  immigrate  —  something  more.  We  may 
leave  open  the  question  as  to  whether  this 
income  determined  by  pre-capitalistic  conditions, 
is  best  explained  by  emphasizing  the  customary 
standard  of  living,  or  the  narrow  productive 
opportunities  of  these  workers.  For  us  the 
significant  fact  is  that  this  income  plus  an 


THE  SUPPLY  OF  LABOR  125 

amount  sufficient  to  act  as  inducement  to 
emigrate  to  the  regions  of  modern  industry, 
is  the  price  which  must  be  paid  to  secure  the 
lower  grades  of  labor  for  our  industries. 

For  the  higher  grades  there  enter  other  factors, 
less  easily  summarized  in  general  formulae. 
Often  it  will  be  necessary  to  regard  the  supply 
of  certain  kinds  of  skilled  labor  as  practically 
fixed.  So  far  as  it  is  possible  to  make  out  a 
"supply  price"  for  an  additional  amount  of 
one  of  the  higher  grades,  it  equals  the  wages 
of  unskilled  labor,  —  determined,  as  we  have 
seen,  in  large  part  by  non-capitalistic  condi- 
tions, —  with  enough  in  addition  to  induce 
part  of  the  working  population  to  undergo  the 
necessary  training,  or  to  bear  the  expense  of 
educating  their  children,  towards  a  more  spec- 
ialized or  more  intelligent  type. 

The  price  of  unskilled  labor,  therefore,  is 
fundamental  to  the  determination  of  the  wages 
of  all  grades  of  employment.  From  the  point 
of  view  of  capitalistic  industry  it  is  cost  rather 
than  utility  that  makes  the  supply  price  of 
labor.  In  other  words,  the  average  income  set 
by  conditions  outside  of  capitalistic  industry 
enters  as  an  independent  factor  into  the  deter- 
mination of  wages  paid  in  capitalistic  industries. 

If  the  views  set  forth  above  are  correct,  we 
may  speak  of  a  fairly  definite  supply  price  for 
labor.  It  varies  both  with  the  grade  of  labor  and 
with  locality.  At  the  distant  sources  of  our 


126  PROFIT  AND  WAGES 

immigrant  labor,  in  the  backward,  rural  dis- 
tricts of  the  old  world,  a  fairly  stable  standard 
of  living  makes  a  rise  or  fall  of  wages  result 
respectively  in  an  increase  or  decrease  in  the 
rate  of  growth  of  the  population.  Such  adjust- 
ments of  the  supply  of  labor,  however,  are 
slow  and  imperfect.  For  the  areas  of  capital- 
istic enterprise,  the  important  factor  deter- 
mining supply  of  labor  is  immigration.  More 
or  less  of  immigrant  labor  can  be  attracted  as 
wages  are  raised  or  lowered. 

An  important  part  of  the  supply  price  con- 
sists of  the  amount  necessary  to  act  as  induce- 
ment to  undergo  the  expense  and  hardship  of 
immigration.  The  supply  price  of  labor  will, 
therefore,  tend  to  vary  directly  with  the  distance 
from  the  sources  of  immigrant  labor  and  with 
the  perfection  of  means  of  communication. 
It  is  often  assumed  that  wide  geographical 
differences  in  the  remuneration  of  labor  are 
due  to  corresponding  differences  in  produc- 
tivity.* The  views  just  set  forth  suggest  a 
different  explanation  of  the  undoubted  fact 
that  where  wages  are  high,  the  productivity 
of  labor  is  likely  to  be  high.  Where,  for  geo- 
graphical reasons,  the  supply  price  of  labor 
is  high,  only  the  most  productive  uses  of  labor 
are  profitable  to  the  employer.  Where,  on  the 
other  hand,  the  supply  price  is  low,  the  appli- 
cation of  successive  "doses"  of  labor  may  be 

*For  instance,  in  discussions  of  the  influence  of  protective  tariffs. 


THE   SUPPLY  OF  LABOR  127 

carried  further  down  the  scale  of  diminishing 
returns,  to  a  lower  margin  of  productivity. 

These  propositions  in  regard  to  the  supply 
price  of  labor  do  not,  of  course,  give  a  complete 
explanation  of  the  wage  level.  An  examination 
of  the  forces  making  what  is  called  "demand 
for  labor"  must  be  the  next  step  in  our  analysis. 


CHAPTER  VIII 

THE  THEORY  OF  WAGES.  THE  DEMAND  FOR  LABOR 

The  subsistence  theory  emphasized  factors 
affecting  the  supply  of  labor,  but  implied  the 
action  of  both  demand  and  supply  as  deter- 
minants of  the  price  of  labor.  It  was  avowedly 
only  a  theory  of  what  wages  tended  to  be  in 
the  long  run.  The  wages  fund  theory  of  the 
classical  economists  gave  an  explanation  of 
what  constituted  the  total  demand  for  labor, 
but  fitted  this  into  a  theory  of  temporary 
"market  wages"  only.  There  was  no  reference 
to  what  made  demand  in  the  long  run,  but 
obviously  this  was  determined  by  the  accumu- 
lation of  capital.  The  relation  between  total 
demand  for  labor  and  the  total  working  popu- 
lation determined  wages  for  each  season  of 
employment,  but  in  the  long  run  these  "market 
wages"  or  actual  scales  of  payment  tended 
towards  the  "natural  wage." 

The  wages  fund  doctrine  is  an  example  of 
the  bold  collective  conceptions  of  the  classical 
school.  Brushing  aside  the  factors  entering 
into  all  the  diverse,  particular  wage  contracts, 
it  gave  a  view  of  the  wage  level  as  a  whole,  as 
though  capitalists  united  as  a  class  dealt  with 
labor  as  a  class.  It  rested  on  the  thought  that 
so  viewed,  capitalists  and  laborers  are  forced 
to  make  an  exchange  with  each  other;  that 


THE  DEMAND  FOR  LABOR  129 

each  party  brings  just  one  commodity  to  this 
trade,  the  capitalists  their  capital,  the  laborers 
their  labor  power,  and  that  each  party  is 
obliged  to  give  its  entire  commodity  in  exchange 
for  that  of  the  other. 

In  a  rough  way  these  views  are  true  —  as 
true,  perhaps,  as  any  general  theory  in  this 
field  ever  can  be.  That  the  laborers  have  to 
sell  their  commodity  on  pain  of  starvation  is 
obvious.  To  be  sure,  some  of  them  might 
emigrate,  and  the  supply  of  labor  might  be 
varied  a  little  by  a  greater  or  less  number 
acting  as  their  own  employers  in  agriculture, 
or  as  handicraftsmen,  or  petty  shopkeepers. 
This,  however,  does  not  substantially  qualify 
the  fact  that  the  larger  part  of  the  quantum  of 
labor-power  existing  at  the  time  being  has  no 
"reservation  price,"  that  it  has  to  be  sold  no 
matter  how  low  the  scale 'of  payment.*  That 
despite  this  cruel  necessity  not  all  labor  power 
is  sold  and  that  some  deteriorates  and  becomes 
unsaleable,  are  qualifications  which  may  fairly 
be  omitted  from  a  general  statement  of 
tendencies. 

*It  must  be  remembered  that  at  this  point  we  are  considering 
a  theory  of  the  forces  of  the  moment  only,  those  making 
"market  wages."  In  the  long  run,  of  course,  the  classical 
economists  held  that  cost  of  subsistence  was  a  reservation 
price  for  labor.  It  may  be  remarked  that  they  gave  no  thought 
to  the  fact  that  with  a  fixed  number  of  laborers  employed, 
there  may  still  be  an  increase  or  decrease  in  average  perfor- 
mance, and  that  efficiency  may,  therefore,  be  said  to  have  its 
reservation  price.  However,  we  may  assume  a  standard  of 
efficiency  for  the  time  being,  not  susceptible  of  rapid  change, 
and,  therefore,  not  giving  occasion  for  much  qualification  of 
the  statements  made  above. 


i3o  PROFIT  AND  WAGES 

A  similar  necessity  of  coming  to  terms  rests 
on  the  class  of  capitalists.  They  must  seek 
to  invest  all  of  their  capital  as  long  as  there 
is  a  prospect  of  gain.  They  will  not  succeed 
at  once  in  investing  all,  just  as  some  labor- 
power  fails  to  find  an  immediate  market.  But 
in  order  to  indicate  general  tendencies,  we  are 
justified  in  assuming  that  all  of  the  labor-power 
and  all  of  the  capital  are  disposed  of.  The  efforts 
of  capitalist  and  laborer  to  sell  or  invest  all 
they  have  to  sell  or  invest,  whether  entirely 
successful  or  not,  make  the  rates  of  remuneration 
what  they  are.  The  wages  fund  theory,  like 
other  economic  theories,  only  indicates  the 
point  of  equilibrium  toward  which  economic 
forces  are  working.  It  deals  with  the  statics 
of  the  problem  of  wages.  Friction  and  "dy- 
namic" changes  in  the  factors  assumed  may 
bring  it  about  that  the  point  is  never  actually 
reached.  We  have  in  consequence  to  rest 
satisfied  with  a  formulation  of  tendencies  only. 

But  if  capitalists  succeed  in  investing  all 
of  their  capital,  does  that  mean  that  it  all 
goes  to  pay  wages?  Must  all  investment  be 
regarded  as  fundamentally  an  exchange  between 
capitalist  and  laborer?  May  not  the  capitalist 
employer  use  part  of  his  funds  to  buy  "capital 
goods"  -machines,  for  instance,  —  instead  of 
hiring  labor?  Such  objections,  of  course,  occur 
readily  to  those  who  either  differentiate  wages 
funds  entirely  from  capital  or  regard  them  as 
only  part  of  capital.  If  it  is  permissible  to  look 


THE  DEMAND  FOR  LABOR  131 

at  the  problem  of  wages  from  the  point  of 
view  of  an  individual  business  or  segment  of 
the  long  productive  process,  the  wages  fund 
doctrine,  of  course,  appears  absurd.  But  the 
wages  fund  theory  is  not  one  of  particular 
wages,  or  wages  in  particular  industries,  but 
an  attempt  to  explain  the  general  wage  level. 
It  might  appear,  therefore,  that  the  investment 
of  the  class  of  capitalists  as  a  whole  only  should 
be  taken  into  consideration.  In  that  case  what 
one  capitalist  gives  to  another,  the  price  paid 
for  a  machine,  for  instance,  should  be  eliminated 
from  consideration.  Only  that  is  invested  and 
a  source  of  gain  for  the  capitalist  class  as  a 
whole,  and,  therefore,  to  be  regarded  as  capital, 
which  goes  to  other  classes.  Disregarding 
advance  payments  of  rent,  only  that  which  goes 
to  the  laborers,  i.  e.,  the  wages  fund  is  capital. 
According  as  it  distributed  over  a  large  or  a 
small  number  of  laborers,  it  makes  a  low  or 
high  average  of  payment.  Its  division  between 
different  groups  and  grades  of  labor  may 
change.  Buying  machines  for  an  industry,  for 
instance,  may  mean  diminishing  the  number 
of  workers  employed  and  total  wages  paid  in 
that  particular  industry  wrhile  increasing  the 
employment  and  wages  of  men  engaged  in 
making  machines. 

Such  is  the  view  of  the  effect  of  buying 
additional  machinery  suggested  by  the  concept 
of  capital  for  which  we  have  contended.  But 
the  matter  is  not  quite  so  simple.  It  is  begging 


132  PROFIT  AND  WAGES 

the  question  to  rule  out  from  consideration 
business  outlays  other  than  those  for  wages, 
by  appealing  to  a  definition  of  capital  which 
expressly  excludes  such  outlays.  The  fact 
that  the  wages  fund  alone  is  a  source  of  gain 
to  capitalists  as  a  class,  makes  it  legitimate 
in  a  general  theory  of  distribution,  to  restrict 
the  term  capital  to  this  fund.  But  the  relevant 
question  at  this  point  is  whether  all  of  what  men 
accumulate  for  investment  and  regard  as  "cap- 
ital,' '  ultimately  reaches  the  laborer ;  or  whether 
part  of  it  may  be  paid  to  other  parties,  to  the 
special  group  of  capitalists  who  sell  machines, 
for  instance,  and  be  consumed  by  them.  The 
total  funds  accumulated  for  use  in  business 
must  be  invested.  But  must  they  all  go  to  pay 
wages;  or  if  not,  is  there  a  definite  and  fixed 
part  of  these  investment  funds  destined  exclu- 
sively for  the  payment  of  wages? 

When  entrepreneurs  substitute  the  purchase 
of  machines  for  the  hiring  of  labor,  they  appear 
to  diminish  the  wages  fund.  But  there  must 
occur  an  increased  employment  of  men  in 
making  machines.  Does  this  mean  that  the 
point  of  application  of  the  wages  fund  is  shifted 
without  change  in  the  size  of  the  fund  itself? 
The  prices  paid  for  the  machines  cover  the 
wages  advanced  to  those  who  had  made  them. 
If  these  prices  included  nothing  else,  that  is 
if  employers  simply  spent  their  capital  for 
wages  and,  on  the  return  of  an  equivalent  from 
the  sale  of  the  products,  reinvested  this  and 


THE  DEMAND  FOR  LABOR  133 

again  spent  it  all  for  wages,  —  if,  in  short,  there 
were  no  interest  and  profit  for  the  capitalist; 
then,  indeed,  all  of  the  investment  funds  would 
have  to  go  to  the  laborers,  and  the  only  question 
would  be  as  to  how  the  total  is  divided  between 
different  groups  of  workers.  But  the  price  of 
a  machine  includes  profit  and  interest.  Now 
if,  in  the  language  of  Bohm-Bawerk,  the  average 
production  period  be  lengthened,  that  is  if 
more  of  the  products  of  earlier  labor  be  used 
in  the  later  stages  of  the  production  of  con- 
sumable goods,  then  there  would  be  an  increased 
outlay  not  only  for  labor  at  the  earlier  stages 
but  also  for  profits  and  interest  to  the  capitalists 
in  charge  of  these  stages.  Part  of  what  might 
have  gone  to  the  laborers  at  the  later  stages, 
is  by  this  change  of  the  production  period 
converted  into  profits  for  a  particular  group  of 
capitalists.  Of  course,  coming  to  the  latter 
as  an  increase  of  profit  it  would  probably  be 
invested  at  once  and  most  of  it  used  in  paying 
wages.  If,  however,  this  increment  of  profit 
were  consumed  by  its  recipients,  the  total 
wages  fund  would  be,  to  that  extent,  diminished. 
This  might  appear  to  qualify  seriously  the 
validity  of  the  assumption  necessary  to  the 
wages  fund  doctrine  that  there  is  a  definite 
fund  destined  for  nothing  but  the  payment  of 
wages.  If,  however,  we  consider  the  conditions 
under  which  such  a  contraction  of  the  fund, 
as  has  just  been  suggested,  could  occur,  it  will 
appear  that  it  is  still  allowable  to  make  the 


134  PROFIT  AND  WAGES 

assumption  of  a  fairly  definite  wages  fund. 
The  outcome  of  such  an  extension  of  the  pro- 
duction period,  of  the  increased  material  equip- 
ment of  the  later  stages,  should  be  an  increase 
of  product  and  profit.  What  is  paid  as  profits 
to  the  capitalists  selling  machines  is  an  advance 
payment  of  their  part  in  the  increased  profits 
of  the  longer  productive  process.  The  incre- 
ment of  product  of  the  longer  process  would, 
at  first,  fall  into  the  hands  of  the  employers, 
but  a  large  part  would  be  added  to  capital  and 
pass  into  the  hands  of  the  laborer  as  wages. 
Thus  only  in  the  transition  to  a  longer  produc- 
tion period  would  there  be  a  considerable 
deduction  from  the  funds  destined  to  be  paid 
out  as  wages. 

Moreover  the  substitition  of  machines,  for 
men  on  a  large  scale  would  probably  indicate 
the  appearance  of  inventions  of  a  revolutionary 
character.  Such,  of  course,  appear  from  time 
to  time  but  should  be  regarded  as  dynamic  in 
character.  They  may  change  some  of  the 
factors  of  the  problem,  such  as  the  size  of  the 
investment  fund  and  the  proportion  of  it  used 
in  paying  wages,  and  bring  about  a  new  resultant 
average  wage.  The  theory  we  are  considering, 
however,  treats  only  of  the  static  aspects  of 
the  problem  of  wages.  To  be  sure,  Bohm- 
Bawerk  argues  that  apart  from  inventions, 
that  is  taking  a  static  point  of  view,  the  average 
production  period  could  be  advantageously 
lengthened,  if  it  were  not  for  the  lack  of  "cap- 


THE  DEMAND  FOR  LABOR  135 

ital."  His  argument,  however,  rests  on  the 
assertion  of  the  possibility  of  an  indefinite 
increase  of  the  rate  of  productivity  with  every 
extension  of  the  production  period,  that  is  with 
every  increase  of  material  equipment  to  labor 
employed.  This  assertion  has  been  shown  in 
an  earlier  chapter  to  be  an  error.*  In  times 
of  abundant  capital  it  is  likely,  therefore,  that 
the  productively  most  advantageous  proportion 
of  equipment  has  been  reached  by  all  entre- 
preneurs except  those  doomed  to  fail.  In  other 
words,  for  every  commodity  there  is  a  pro- 
duction period  not  likely  to  be  greatly  changed 
except  by  the  dynamic  factor  of  invention. 
When  this  has  been  reached,  the  wages  fund 
may  be  regarded  as  a  fairly  definite  proportion 
of  the  total  funds  for  investment. 

It  may  be  remarked  in  this  connection  that 
Bohm-Bawerk  has  set  forth  a  theory  of  general 
wages  which  is  virtually  a  wages  fund  theory, 
though  he  would  not  have  it  so  regarded.  It 
adds  an  element  not  developed  in  the  classical 
doctrine  by  showing  that  a  given  fund  may  be 
used  to  hire  labor  for  longer  or  shorter  periods. 
Unless  the  length  of  the  period  is  established, 
the  average  wage  remains  indeterminate.  An 
increase  of  capital  (of  what  Bohm-Bawerk 
calls  the  "subsistence  fund"),  instead  of  giving 
a  corresponding  increase  of  wages  to  a  fixed 
number  of  laborers,  might  be  employed  in  part 
to  lengthen  the  production  period.  The  problem 

*See  note  page  24. 


1 36  PROFIT  AND  WAGES 

of  the  determination  of  wages,  therefore,  becomes 
that  of  showing  how  the  efforts  of  the  class  of 
entrepreneurs  to  secure  a  maximum  gain  for 
themselves,  establishes  an  equilibrium  between 
three  factors,  —  the  given  subsistence  fund, 
the  total  number  of  laborers,  and  the  length 
of  the  production  period.  In  developing  this 
idea,  Bohm-Bawerk  assumes  that  there  is  an 
unlimited  possibility  of  increasing  per  capita 
product  by  lengthening  the  production  period. 
As  has  been  shown,  however,  there  is  a  maximum 
of  product  attainable.  If  the  supply  of  capital 
is  such  that  the  point  of  maximum  productivity 
has  been  reached,  the  production  period  is  fixed 
and  the  conditions  assumed  by  the  older  wages 
fund  doctrine  prevail  —  that  is,  the  wages 
fund  and  the  number  of  laborers  alone  determine 
the  level  of  wages.  Under  such  static  conditions 
an  increased  investment  of  capital  cannot  advan- 
tageously make  a  longer  production  period. 
It  can  only  enlarge  the  total  productive  enter- 
prise by  starting  additional  business  units  or 
enlarging  existing  ones.  Even  this  is  impossible 
unless  the  increase  of  capital  is  accompanied 
by  an  increased  supply  of  labor.  If  the  labor 
supply  increases  less  rapidly  than  capital,  a 
rise  of  the  wage  level  must  ensue. 

It  is  a  necessary  assumption  of  the  wages 
fund  theory  that  there  is  a  fairly  definite  fund 
all  of  which  will  be  used  in  the  payment  of 
wages.  To  state  it  more  cautiously,  there  will 
be  an  attempt  to  use  all  of  it  and  that  means 


THE  DEMAND  FOR  LABOR  137 

paying  it  out  in  wages.  And  the  attempt  to 
use  all  of  the  fund  is  an  important  determinant 
of  average  wages.  It  would  be  fatal  to  the 
theory  if  it  could  be  shown  that  the  fund  was 
capable  of  rapid  contraction  whenever  the 
wage  level  was  not  altogether  pleasing  to 
capitalists.  Of  course,  the  possibility  of  erratic 
outside  forces  suddenly  destroying  capital  or 
blocking  its  investment  is  not  relevant.  And 
from  any  point  of  view  it  must  be  assumed  that 
the  wages  paid  are  less  than  the  value  of  the 
product  turned  out.  There  must  be  some 
profit.  But  we  should  have  to  reject  the  theory 
if  it  could  be  shown  that  dissatisfaction  with 
the  general  rate  of  profit  resulted  immediately 
in  a  contraction  of  the  wages  fund,  or  in  other 
words,  that  capitalists  would  hold  back  from 
employment  any  considerable  part  of  their 
wages  fund  while  there  was  still  any  profit  to 
be  gained. 

Our  discussion  up  to  this  point  has  been  in 
defense  of  the  wages  fund  theory  and  in  support 
of  its  assumption  of  a  fund  not  capable  of 
rapid  contraction.  We  have  not,  however,  as 
yet  examined  some  of  the  arguments  which, 
when  brought  against  it  in  the  sixties  and 
seventies  of  the  last  century,  led  to  its  sudden 
and  all  too  complete  abandonment.  The  critics 
of  that  time  aimed  to  demonstrate  a  ready 
expansibility  of  the  total  of  funds  destined 
for  the  employment  of  labor.  Little  was  said 
about  a  contract ibility  of  the  fund,  though 


138  PROFIT  AND  WAGES 

of  course,  that  quality  might  be  assumed  as 
implied  in  its  expansibility.  The  turn  the 
discussion  took  was,  no  doubt,  the  result  of 
the  use  which  had  been  made  of  the  theory  by 
opponents  of  trade  unionism.  Could  an  organ- 
ized group  of  laborers  get  higher  wages  without 
a  corresponding  reduction  of  the  remuneration 
of  other  workingmen,  or  was  the  total  which 
might  be  paid  to  the  laboring  classes  rigidly 
limited?  That  was  the  question  upon  which 
all  arguments  tended  to  converge. 

Unfortunately  the  attacks  upon  the  wages 
fund  theory  were  based  on  a  misconception, 
though  a  pardonable  one,  in  view  of  the  care- 
lessness with  which  the  theory  was  usually 
formulated.*  The  fund  was  thought  of  as 
money,  not  as  real  income;  the  wages  paid 
as  money  wages,  not  as  real  wages.  Viewed 
thus  it  was  readily  seen  that  credit  currency 
added  an  elastic  element  to  the  fund.  Of 
course  credit  is  somewhat  limited  by  the  quantity 
of  cash  underlying  it.  Beyond  a  certain  point 
further  expansion  is  impossible  unless  all  con- 
siderations of  safety  are  thrown  to  the  wind. 
It  would  take  us  too  far  afield  to  consider  all 
the  conditions  of  credit  expansion  and  con- 
traction. Only  in  so  far  as  the  wage  level  is 
concerned  with  such  fluctuation  is  the  matter 
at  all  relevant  to  our  discussion.  Other  factors, 
such  as  speculation  and  political  rumor,  epi- 
demics of  optimism  or  depression,  perhaps 

"Taussig,  Wages  and  Capital,  Chapter  XII. 


THE  DEMAND  FOR  LABOR  139 

most  of  the  forces  determining  the  degree  of 
credit  expansion,  must  be  regarded  as  dis- 
turbing outsiders  by  the  theory  of  wages. 
The  thought  of  these  forces  suggests  how 
inadequately  the  confused  and  shifting  reality 
is  described  by  general  theory  and  should  teach 
caution  in  the  application  of  abstract  doctrine 
to  concrete  problems.  But  if  general  theory 
is  at  all  permissible,  then  the  theorist  is  war- 
ranted in  disregarding  such  disturbing  factors 
and  proceeding  as  if  they  did  not  exist.  One 
of  the  traditional  and  necessary  methods  of 
economic  theory  is  to  disregard  the  existence 
of  a  fluctuating  supply  of  money  and  credit, 
and  to  fasten  the  attention  on  real  income  only. 
Now  what  of  the  wages  fund  when  thought 
of  as  real  income,  as  a  stock  of  subsistence  or 
consumers'  goods  such  as  laborers  could  con- 
sume? This  evidently  at  any  particular  time 
is  very  little  subject  to  possible  increase.  If 
the  wages  fund  theory  be  thought  of  as  applying 
only  to  the  market  wages  of  the  moment,  or 
of  a  short  season,  it  is  obviously  right  in  its 
assumption  of  a  predetermined,  possible  total 
of  wages.  If,  for  instance,  an  aggressive 
trade-unionism  could  force  an  increase  of  money 
wages,  there  would,  for  a  time,  be  no  corre- 
sponding or  considerable  rise  of  real  wages. 
If  the  increased  funds  needed  to  pay  higher 
wages  were  made  possible  by  an  expansion  of 
credit,  the  money  and  credit  left  to  the  class 
of  employers  generally  for  their  personal  use 


140  PROFIT  AND  WAGES 

would  not  be  diminished.*  In  any  case,  the 
capitalist  and  employing  classes  would  not 
diminish  their  consumption  of  necessaries  but, 
if  any  economy  became  necessary,  would  exercise 
it  by  a  decreased  purchase  of  luxuries.  With  an 
increasing  money  demand  for  necessaries  from 
the  laboring  class  and  no  falling  off  of  demand 
from  other  classes,  prices  of  necessaries  would 
rise  and  real  wages  to  that  extent  would  fail 
to  increase.  It  appears,  therefore,  that  if  only 
the  immediate  results  of  a  general  rise  of  money 
wages,  such  as  we  have  supposed,  were  to  be 
considered,  there  would  be  no  sufficient  reason 
for  calling  the  wages  fund  doctrine  into  question. 
If,  however,  a  longer  period  of  time  be  taken 
into  view,  it  will  appear  that  the  greater  profits 
gained  by  producers  of  necessaries  would  lead 
to  a  shifting  of  capital  from  the  production 
of  luxuries  to  that  of  necessaries  and  then  the 
higher  level  of  money  wages,  if  still  maintained, 
would  mean  a  higher  average  of  real  wages. 
The  higher  scale  of  payment  for  labor  would 
correspond  to  a  larger  wages  fund  but  the 
increase  of  the  fund  would  appear  as  the  effect, 
and  not  as  the  cause,  of  the  higher  level  of 
wages.  Capital  funds  used  to  raise  wages  would 
have  been  created  by  credit  expansion.  That 
part  of  the  real  income  of  the  capitalist  class 
consisting  of  luxuries  would  have  been  dimin- 
ished. But  all  this  can  be  thought  of  as  happen- 

*Such    aggressive    and    successful    unionism,    however,    might 
cause  a  shrinkage  of  credit. 


THE  DEMAND  FOR  LABOR  141 

ing  only  on  the  assumption  that  capitalists 
as  a  whole  do  not  increase  the  quantity  of 
money  income  spent  for  consumers'  goods, 
or  in  other  words,  that  they  are  content  to 
consume  fewer  goods  while  saving  as  large  a 
money  fund  for  investment  as  before.  Unless 
there  is  as  much  saved  as  before,  capital  and 
the  wages  fund  will  be  diminished,  and  the 
general  rise  of  wages  will  have  been  but  a 
temporary  one. 

With  a  very  thrifty  capitalist  class,  deter- 
mined never  to  lessen  its  annual  saving,  a 
general  rise  of  wages  at  the  expense  of  profit 
and  of  the  current  consumption  of  the  rich,  is 
conceivable.  In  a  theoretical  discussion  it 
may  be  given  some  weight.  But  it  should  be 
noted  that  if  this  constitutes  an  objection  to 
the  wages  fund  theory,  it  is  one  of  which  most 
of  the  critics  of  that  theory  are  debarred  from 
making  use.  Holding,  as  they  do,  some  form 
of  the  abstinence  theory,  they  should  argue 
that  no  permanent  increase  of  the  wages  fund 
at  the  expense  of  profit  and  interest  is  possible. 

The  theory  which  most  gains  support  from 
the  possibility  of  an  increase  of  the  total  of 
real  wages  through  aggressive  labor  organization 
is  that  which  may  be  called  the  "bargain 
theory"  —  the  theory  that  the  respective  shares 
of  capitalist  and  laborer  depend  on  the  outcome 
of  a  struggle  between  them.  That  this  theory 
emphasizes  an  important  factor  in  the  making 
of  actual  wage  scales,  no  one  conversant  with 


1 42  PROFIT  AND  WAGES 

the  facts  would  deny.  Whatever  general  theory 
of  wages  we  come  to  accept,  we  must  give  some 
recognition  to  this  factor,  at  least  as  supple- 
menting the  main  propositions  of  our  theory. 
The  present  writer  would  hold,  however,  that 
the  statement  that  wages  are  determined  by 
a  struggle  or  bargain,  —  the  outcome  of  which 
is  largely  decided  by  the  relative  aggressiveness 
and  obstinacy  of  the  contending  parties,  — 
while  true,  does  not  carry  analysis  as  far  as 
it  should  be  carried.  Our  theory  should  aim 
to  note  the  effect  of  the  resources  and  strategic 
positions  of  both  parties  on  the  issue  of  the 
struggle.  Without  such  further  development 
of  the  analysis,  the  positive  contribution  of  the 
theory  would  be  little  more  than  a  truism, 
while  its  negative  implication  that  there  is 
nothing  more  to  be  said,  would  be  an  evasion 
of  all  the  difficulties  of  the  problem. 

As  our  discussion  has  shown,  the  account 
given  by  the  wages  fund  theory  of  how  the 
general  scale  of  wages  is  made,  fails  to  allow 
for  many  disturbing  factors.  It  is  a  very 
abstract  doctrine  and  would  need  to  be  supple- 
mented and  qualified  extensively  before  it 
could  be  regarded  as  anything  but  a  very  rough 
approximation  to  reality.  Why  give  it  any 
thought  at  all  if  it  falls  so  far  short  of  giving  a 
definite  and  accurate  picture  of  industrial  facts? 
The  answer  to  this  objection  is  that  the  wages 
fund  theory  gives  what  no  other  theory  has 
given  or  can  give  —  an  explanation  of  the 


THE  DEMAND  FOR  LABOR  143 

general  wage  level  as  distinguished  from  com- 
parative or  particular  wages.  It  is  analogous 
to  the  so-called  "quantity  theory"  of  money 
or  theory  of  the  general  price  level,  and  as 
necessary  to  the  explanation  of  actual  wages 
as  the  quantity  theory  is  to  that  of  actual 
prices.  The  theory  of  particular  or  comparative 
wages,  like  the  theory  of  relative  prices  of 
commodities,  or,  as  it  is  ordinarily  called,  the 
theory  of  "value,"  presupposes  a  general  level. 
Both  of  these  theories  of  relative  magnitude 
must  assume  a  given  fund  or  flow,  the  one  a 
wages  fund,  the  other  a  given  quantum  of 
money  and  credit.  The  problem  in  both  cases 
is  how  the  fund  is  divided  up  between  particular 
values  or  prices.  For  the  purposes  of  a  general 
theory  of  distribution,  however,  we  need  to 
explain  the  absolute  height  of  wages,  not  the 
comparative  scale  of  payment  of  different  classes 
of  labor.  In  order  to  explain  how  the  marginal 
product  is  divided  between  capital  and  labor, 
it  is  necessary  to  show  not  why  one  set  of 
laborers  get  more  than  another  but  what 
determines  either  the  average  or  the  total  of 
wages.  Only  on  that  basis  can  the  share  going 
to  capital  be  accounted  for. 

No  theory  other  than  that  of  the  wages  fund 
can  properly  be  called  a  theory  of  general  wages 
or  of  the  general  wage  level.  The  subsistence 
theory,  though  contributing  to  the  explanation 
of  both  general  and  relative  wages,  is  con- 
fessedly incomplete  and  can  serve,  at  best, 


144  PROFIT  AND  WAGES 

only  as  part  of  a  complete  explanation.  The 
productivity  theory,  practically  the  only  wage 
theory  to  have  gained  general  acceptance, 
though  professing  to  explain  general  wages, 
has  unconsciously  applied  a  method  of  reasoning 
permissible  only  to  an  explanation  of  particular 
wages.  This  aspect  of  current  speculation  on 
wages,  and  the  productivity  theory  in  general, 
must  now  be  subjected  to  a  critical  examination. 

Although  some  assumptions  in  regard  to 
the  supply  of  labor  must  be  pre-supposed,  the 
productivity  theory  in  its  usual  formulation 
is  devoted  entirely  to  an  analysis  of  the  forces 
on  the  side  of  demand.  This  one-sided  emphasis 
has  doubtless  been  favored  by  the  Austrian 
theory  of  value  with  its  analysis  of  demand 
as  varying  with  the  utility  and  price  of  the 
commodity  demanded.  Applied  with  great 
success  to  the  elucidation  of  the  value  of  con- 
sumers' goods,  this  theory  of  value  was  at 
once  extended  to  producers'  goods  including 
labor.  No  questions  were  raised  as  to  whether 
demand  for  labor  might  not  differ  radically 
from  demand  for  consumers'  goods.  Labor 
was  described  as  subject  to  a  law  of  diminishing 
productivity  homologous  with  the  diminishing 
utility  of  the  unit  of  an  increasing  quantity  of 
a  consumer's  good,  and  its  market  value  as 
determined  by  the  utility,  that  is  the  pro- 
ductivity, of  the  marginal  unit,  to  the  buyer. 

Now  this  description  of  demand  for  labor 
as  of  altogether  the  same  nature  as  that  for 


THE  DEMAND  FOR  LABOR  145 

consumable  commodities,  leads  to  an  erroneous 
conception  of  the  demand  as  almost  indefinitely 
extensible.  Demand  for  a  consumption  good 
means  the  offer  of  a  part  only  of  the  purchasing 
power  in  the  hands  of  the  consumer,  the  total 
being  distributed  among  a  large  number  of 
consumable  commodities.  Demand  for  any 
of  these  goods  can  be  almost  indefinitely  in- 
creased by  abstaining  from  or  diminishing  the 
purchase  of  other  goods.  If  good  A  rises  in 
utility  as  compared  with  B,  C  and  D,  the 
demand  for  it  increases  while  that  for  B,  C  and 
D  falls  off.  Demand  for  labor,  viewing  it 
collectively  and  not  from  the  point  of  view  of 
one  industry  or  of  a  single  industrial  establish- 
ment, is  limited  by  the  total  of  funds  destined 
for  the  payment  of  wages.  These  funds,  how- 
ever, instead  of  being  assigned  to  the  purchase 
of  a  vast  variety  of  things,  as  are  consumers' 
funds,  are  intended  for  the  purchase  of  labor 
alone.  There  is  no  choice  between  different 
goods  with  the  possibility  of  increasing  demand 
for  any  of  them  by  withdrawing  funds  from  the 
purchase  of  the  others.  Entrepreneurs  may 
choose  between  the  production  of  a  great  diver- 
sity of  goods  but  whatever  their  choice,  it 
involves  the  purchase  of  labor,  the  universal 
requisite  of  the  productive  process.  In  the 
use  of  the  wages  fund  they  have  no  choice 
between  different  things  but  only  between 
different  uses  of  the  same  thing. 


146  PROFIT  AND  WAGES 

In  short,  there  is  a  fund  all  of  which  must  be 
invested  and  the  size  of  which  is  an  important 
determinant  of  the  level  of  prices  paid  for  labor. 
It  is  distributed  as  wages  among  different  grades 
of  work  in  such  manner  as  to  tend  towards  an 
equality  in  the  marginal  rate  of  profit.  Such  a 
distribution  of  the  fund  makes  the  wages  of 
different  kinds  of  labor  vary  according  to  their 
marginal  productivity.  But  it  would  be  an 
error  to  leap  to  the  conclusion  that,  because 
comparative  wages  are  graded  according  to 
productivity,  wages  are  equal  to  the  marginal 
product  of  labor  (or  the  marginal  product 
discounted)  and  that  productivity  directly  deter- 
mines the  absolute  as  well  as  the  relative  scale 
of  payment.*  Productivity  may  be  appealed 
to  for  the  purpose  of  explaining  comparative 
rates  of  remuneration  only.  As  a  theory  of 
relative  wages,  the  productivity  theory  may  be 
accepted  as,  at  least,  a  fairly  satisfactory  partial 
explanation  of  existing  wage  scales.  Its  pretense 
to  a  valid  explanation  of  general  wages,  however, 
must  be  rejected.  The  absolute  scale  of  pay- 
ment, the  general  level,  can  be  explained  only 
by  a  reference  to  the  total  of  purchasing  power 
directed  to  the  employment  of  labor. 

This  brings  us  back  to  the  wages  fund  theory. 
We  may  regret  that  it  seems  vague  and  exces- 
sively abstract,  —  that  only  by  admitting  exten- 

*This  is  the  error  of  a  considerable  part  of  the  attempted  statis- 
tical verification  of  the  productivity  theory  by  Professor 
Moore  (Laws  of  Wages,  especially  in  Chapters  IV  and  VI). 


THE  DEMAND  FOR  LABOR  147 

sive  qualifications  and  exceptions,  it  can  be 
made  to  appear  as  an  approximately  accurate 
picture  of  reality.  The  aim  of  economic  thought, 
however,  should  be  to  specify  and  formulate  as 
accurately  as  possible  the  various  qualifying 
propositions  which  are  to  be  made,  but  to  treat 
these  as  developments  or  modifications  of  the 
wages  fund  doctrine,  not  as  grounds  for  rejecting 
it  in  toto.  The  attitude  of  a  large  number  of 
economists  towards  the  quantity  theory  of 
money  might  well  indicate  the  treatment  which 
should  have  been,  but  was  not,  accorded  to 
the  wages  fund  doctrine.  Various  efforts  at 
precise  statement  of  all  the  factors  determining 
the  general  price  level  have  given  us  something 
much  more  complicated  and  perplexing  than 
the  bold  and  crude  quantity  theory  of  an 
earlier  time.  But  for  all  these  developments 
of  the  theory,  there  is,  on  the  whole,  little 
disposition  to  deny  that  the  existing  quantum 
of  money  is  one  of  the  most  important  factors 
in  making  the  scale  of  prices,  and  that  the 
quantity  theory  needs  to  be  perfected,  not 
rejected. 

The  objections  raised  above  to  the  productiv- 
ity theory  may  be  made  somewhat  clearer  by 
diagrams.  These,  it  may  be  remarked,  will 
aid  us  in  our  constructive  as  well  as  in  our 
critical  task.  In  Figure  I  a  fixed  supply  of 
labor  (ab)  is  assumed,  a  condition  conceivable 
as  true  for  short  periods;  ir.  Figure  II  a  varia- 
ble supply  with  an  increasing  supply  price 


148 


PROFIT  AND  WAGES 


represented  by  an  ascending  supply  curve.  Since 
the  productivity  theory  regards  wages  as  deter- 
mined by  marginal  productivity  and  the  location 
of  the  margin  depends  on  the  number  of  laborers 
employed,  some  assumptions  must  be  made 
in  regard  to  supply.  The  two  most  probable 
cases  are  given  and  they  are  not  such  as  could 
in  reason  be  objected  to  by  adherents  of  the 
productivity  theory.  To  simplify  the  problem 
it  is  assumed  that  there  is  only  one  grade  of 
labor.  As  usual,  distance  along  the  abscissa 
or  base  line  represents  supply  or  numbers  of 
laborers.  The  distance  of  points  on  the  curve 
ec  from  the  base  line  represents  productivity. 


5  a 


Figure  I 


Figure  II 


Now  the  productivity  theorist  would  assume 
that  the  productivity  curve  ec  may  be  regarded 
as  a  demand  curve,  representing  what  employers 
could  pay  without  loss  for  different  quantities 
of  labor.  Under  the  given  conditions  of  supply 
they  would  hold  that  the  price  per  unit  of  labor 


THE  DEMAND  FOR  LABOR  149 

would  come  to  equal  be.*  But  at  this  point 
there  has  crept  in  the  common  error  that  what 
is  possible  for  one  or  for  a  few,  is  possible  for 
all.  An  individual  employer  could  pay  labor 
what  it  produces  at  the  margin  (discounted). 
If  his  capital  was  insufficient  for  this  outlay, 
he  could  borrow.  But  the  totality  of  employers 
could  not  do  this  unless  the  total  funds  available 
for  the  payment  of  wages  equalled  marginal 
product  per  unit  of  labor  multiplied  by  the 
whole  number  of  units  employed.  In  other 
words  the  collective  wages  fund  would  need 
to  be  equal  to  what  is  represented  by  the 
rectangle  abed  in  each  diagram.  If  it  were 
less  than  this,  —  if,  for  instance,  it  equalled 
the  shaded  portion  of  each  diagram,  the  rate 
of  payment  per  unit  of  labor  would  be  indicated 
by  the  width  of  this  shaded  strip  (bbr  in  Figure 
I,  fg  in  Figure  II).  It  could  not  be  more  than 
that  but  would  tend  to  equal  all  of  it. 

There  is  an  assumption  underlying  the  pro- 
ductivity theory  that  wages  are  paid  out  of 
current  product;  in  other  words,  that  the 
labor  of  a  given  week  or  month  is  paid  out  of 
the  product  of  that  week  or  month.  If  that 
assumption  were  valid,  labor's  productivity 
would  create  the  fund  out  of  which  it  is  paid 

*If  we  assume  that  employers  would  not  in  any  case  pay  more 
than  the  discounted  value  of  the  product  as  wages,  the  curve 
ec  could  be  taken  to  represent  discounted  value  of  product. 
If  it  represents  full  value  of  product,  then  the  wages  per  unit 
of  labor  would  be  something  less  than  cb,  and  in  the  case 
illustrated  by  Figure  II  something  less  than  ab  of  labor  would 
be  employed. 


1 50  PROFIT  AND  WAGES 

and  it  would  be  quite  possible  to  pay  labor  the 
full  equivalent  of  its  product.  But  if  we  look, 
not  at  the  money  funds  involved,  but  at  real 
income,  it  is  obvious  that  the  larger  part  of 
the  current  product  consists  of  unfinished  goods, 
or  what  Bohm-Bawerk  would  call  "future 
goods;"  and  that  the  consumable  wealth  of 
which  the  real  wages  of  labor  consist  is,  for  the 
most  part,  the  product  of  labor  performed 
weeks  or  months  ago.  The  notion  that  wages 
could  be  paid  out  of  current  product  grew  in 
part  out  of  the  onslaught  made  on  a  misunder- 
stood wages  fund  doctrine.  The  misconception, 
already  referred  to  in  this  chapter,  of  the  wages 
fund  as  consisting  of  money  or  a  sum  of  value 
expressed  in  terms  of  money,  suggested  that  by 
means  of  credit  the  cash  proceeds  from  the  sale 
of  current  product  could  be  anticipated  and 
used  to  pay  current  wages.  With  less  anxiety 
to  have  done  with  the  wages  fund  theory,  and  a 
clearer  general  view  of  the  production  and  dis- 
tribution of  real  as  distinguished  from  money 
income,  of  the  relation  of  past  to  present  and 
future  in  the  continuous  flow  of  products, 
economic  theory  might  have  kept  a  better 
perspective  and  a  stronger  grasp  on  the  funda- 
mental factors. 

Confusion  also  grew  out  of  the  unfortunate 
tendency  to  look  at  things  too  exclusively  from 
the  point  of  view  of  an  individual  employer  or 
business.  It  brought  into  the  mental  fore- 
ground the  individual  employer's  estimate  of 


THE  DEMAND  FOR  LABOR  151 

what  wages  he  could  pay  as  dependent  on  the 
anticipated  value  of  the  product,  but  failed  to 
place  in  strong  relief  the  important  fact  that 
collectively  capitalists  and  employers  could 
not  or  would  not  advance  in  wages  more  than 
what  they  had  saved  out  of  past  product  and 
destined  for  investment. 

Now  let  us  return  to  the  consideration  of 
our  diagrams  in  order  to  examine  certain 
objections  which  might  occur  to  the  -reader. 
The  difference  between  the  wage  and  the 
marginal  product  constitutes  the  profit  of  capital, 
equal  in  Figure  I  to  cb'  and  in  Figure  II  to  the 
extension  of  fg  necessary  to  reach  the  curve 
ec.*  The  rate  of  profit  as  indicated  in  Figure 

I  would  be  7/7  .  Owing  to  the  mobility  of  cap- 
ital, always  cheerfully  taken  for  granted  in 
economic  theory,  there  would  be  a  tendency 
towards  the  same  marginal  rate  throughout 
the  entire  industrial  field,  and  wages  every- 
where would  tend  to  equal  the  marginal  product 
discounted  by  the  prevailing  rate  of  profit. 

As  a  statement  of  what  wages  equal,  of  the 
amount  of  wages,  this  is  in  agreement  with  the 
productivity  theory.  Not,  however,  as  a  formu- 
lation of  the  process  by  which  wages  are  deter- 
mined. Our  argument  shows  wages  to  be 
determined,  not  by  the  productivity  of  labor 

*Assuming  that  the  curve  ec  represents  the  full,  not  a  discounted, 
value  of  the  product  —  an  assumption  we  make  from  this 
point  on. 


i52  PROFIT  AND  WAGES 

and  an  independently  established  rate  of  dis- 
count, as  the  productivity  theorist  would  hold, 
but  by  the  wages  fund  and  the  number  of 
laborers,  under  the  conditions  given  in  Figure  I ; 
and  by  the  wages  fund  and  the  supply  prices 
of  labor,  under  the  conditions  of  Figure  II. 
Profit  is  shown  to  be  a  residual  left  after  wages 
are  paid,  and  the  rate  of  profit  the  result,  and 
not  a  cause,  of  the  scale  of  wages. 

Adherents  of  the  abstinence  and  time-prefer- 
ence theories,  however,'  would  hold  that  the 
prevailing  rate  of  profit  (at  least  under  static 
conditions)  is  a  necessary  rate  determined  by 
cost  of  abstinence  or  waiting,  or  by  the  rate 
of  time-preference  or  something  of  that  sort. 
If  the  rate  of  profit  were  more  than  this,  they 
might  argue,  there  would  be  an  increase  of 
capital,  that  is,  of  the  wages  fund,  and  a  con- 
sequent rise  of  wages  until  the  diminished 
rate  of  profit  was  no  longer  sufficient  to  cause 
any  further  increase  of  capital.  Then  wages 
would  be  equal  to  marginal  product  discounted 
according  to  an  independently  determined  rate 
of  discount  (a  rate  determined  by  subjective 
factors) .  Product  and  the  rate  of  discount  would 
appear  to  be  the  two  determinants  of  wages 
and  we  should  apparently  have  reached  the 
productivity  theory  of  wages  now  most  in  favor. 
It  should  be  noted,  however,  that  the  degree 
of  marginal  productivity  of  labor  is  not,  in  this 
way,  proved  to  be  the  direct  and  immediate 
determinant  of  wages  which  the  prevailing 


THE  DEMAND  FOR  LABOR  153 

theory  seems  to  consider  it,  but  acts  through 
the  amount  of  accumulation  of  capital  which 
it  makes  possible.  If,  for  instance,  there  were 
a  general  increase  of  productive  power  —  which 
could  be  represented  diagrammatically  by  a 
productivity  curve  drawn  at  a  greater  distance 
from  the  horizontal  base  line  —  wages  would 
not  rise  until  the  higher  profits  had  resulted  in 
an  increase  of  capital  with  which  to  pay  wages. 
The  strongest  objection,  however,  to  regarding 
wages  as  determined  by  the  discounted  marginal 
product,  is  the  consideration  that  the  rate  of 
discount  cannot  enter  into  the  determination 
of  wages  as  an  independent  factor  but  is  itself 
determined  by  the  prevailing  price  of  labor. 
It  is  not  true  that  capital  must  grow  until  there 
results  a  necessary  rate  of  profit  which  makes 
further  increase  of  capital  impossible.  There 
is  probably  no  rate  so  small  as  to  stop  altogether 
the  further  growth  of  capital.  The  largest 
accumulations  are  made  out  of  the  differential 
gains  of  earlier,  or  intramarginal  investments, 
and  are  not  much  affected  by  the  decreasing 
rate  of  gain  left  to  additional  supplies  of  capital. 
Some  saving  would  occur  if  there  were  no  interest 
or  profit  at  all,  and  capital  once  accumulated 
is  not  willingly  consumed.  In  any  case,  as 
shown  in  the  chapter  on  the  abstinence  theory, 
the  great  forces  determining  the  supply  of 
capital  and  thereby  the  marginal  rate  of  return, 
have  very  little  connection  with  the  dubious 


i54  PROFIT  AND  WAGES 

and  uncertain  subjective  factors  emphasized 
by  the  abstinence  and  time-preference  theories. 

No  general  and  simple  explanation  of  what 
makes  the  total  of  capital  or  of  the  wages  fund 
is  possible.  The  theory  of  distribution,  therefore, 
must  rest  satisfied  to  assume  the  given  amount 
of  capital  as  one  of  its  data.  As  to  wages,  we 
may  say  that  the  wages  fund  and  the  factors 
regulating  the  supply  of  labor  are  the  chief 
determinants.  Productivity  plays  no  part  except 
for  its  permissive  influence  on  the  accumulation 
of  capital.  Marginal  productivity  has  but 
a  small  share  in  this  indirect  influence  on  wages 
because  most  capital  is  accumulated  out  of 
earlier  or  intramarginal  investments.  As  to 
the  rate  of  discount,  that  cannot  be  thought  of 
as  determined  independently  of  wages.  What- 
ever tenuous  connection  may  exist  between  it 
and  the  subjective  conditions  of  saver  and 
investor,  its  most  important  direct  determinant 
is  the  wage  level.  It  is  an  effect,  not  a  cause 
of  the  scale  of  remuneration  for  labor. 

As  an  explanation  of  general  wages  the 
productivity  theory  should  be  unreservedly 
rejected.  It  has  the  fundamental  defect,  as 
we  have  seen,  of  treating  demand  for  labor  as 
homologous  with  demand  for  particular  con- 
sumers' goods.  As  a  theory  of  the  comparative 
scale  of  payment  of  different  employments 
and  grades  of  labor,  however,  it  is  entitled  to 
consideration.  Possibly  the  failure  of  the  classi- 
cal school  to  set  forth  clearly  the  part  which 


THE  DEMAND  FOR  LABOR  155 

relative  productivity  plays  in  grading  particular 
wages,  may  be  one  reason  why  the  factor  of 
productivity  in  the  end  was  assigned  a  part 
of  greater  importance  than  is  properly  due  to 
it  in  the  theory  of  both  general  and  particular 
wages.  That  the  wages  fund  theory,  being  an 
explanation  of  average  wages  or  the  general 
wage  level  only,  left  unexplained  the  difference 
in  payment  between  various  occupations,  was 
obvious  enough  to  the  classical  writers.  Unfor- 
tunately, however,  their  treatment  of  particular 
wages,  a  problem  of  inferior  theoretical  interest, 
was  somewhat  perfunctory,  and  was  likely 
to  be  no  more  than  a  repetition  of  some  obser- 
vations made  by  Adam  Smith.*  Meanwhile 
superficial  and  optimistic  impressions  of  the 
effect  of  increasing  productivity  on  the  earnings 
of  labor,  together  with  the  shifting  of  the  view 
point  of  economic  reasoning  by  the  so-called 
Austrian  school,  have  given  the  productivity 
theory  a  position  of  unmerited  security. 

Of  course  it  has  not  altogether  escaped  the 
fate  of  all  economic  theories  of  being  called 
into  question  and  denounced  as  fallacious. 
The  usual  point  of  attack,  however,  has  not 
been  that  chosen  in  the  preceding  pages,  but 
one  suggested  by  the  apparent  practical  dif- 
ficulties of  ascertaining  marginal  productivity.* 

"Canaan,  Production  and  Distribution,  1776-1848,  p.  364. 

**See  especially  Arturo  Labriola,  Distribuzione  del  dividendo  e 
produttivita  marginali,  *  Corne"lissen,  Theorie  du  salaire,  and 
two  articles  by  Richard  Schuller  in  the  Archiv  fur  Sozial- 
wissenshaft,  July  and  November,  1911.  Schuller 's  discussion 


156  PROFIT  AND  WAGES 

Can  and  does  an  employer  estimate  the 
marginal  productivity  of  labor,  either  of  that 
which  he  employs  or  of  labor  in  general?  It 
must  be  confessed  that  the  problem  looks 
somewhat  puzzling.  What,  for  instance,  is 
the  size  of  the  marginal  unit?  Is  it  one  man  or 
a  group  of  men?  The  increment  of  product 
due  to  the  last  of  one  hundred  men  taken  on, 
would  be  less  that  the  average  product  per 
man  of  the  group  of  hundred  men.  How  can 
one  know  what  value  to  impute  to  each  of 
several  grades  of  labor  associated  in  varying 
proportions  in  the  production  of  different  com- 
modities and  in  different  industries?  The 
doctors  disagree  in  regard  to  the  laws  of  "impu- 
tation." But  even  if  we  may  accept  one  of  the 
formulations  offered,  does  it  not  require  the 
eye  of  faith  to  detect  the  operation  of  any  such 
law  in  the  actual  world?  Does  not  the  fact  that 
the  employer  usually  estimates,  not  the  product 
of  the  individual  laborer  or  of  a  group  of  laborers, 
but  what  he  calls  his  "labor  cost,"  make  the 
utilitarian  calculus  applied  to  the  purchase  of 
labor  appear  somewhat  unreal? 

However,  labor  cost  is  a  function  of  pro- 
ductivity, and  thus  indirectly  the  productivity 
of  labor  enters  into  the  employer's  estimates 
of  the  advantage  of  hiring  labor.  In  fact  all 

is  especially  suggestive  because  of  its  concrete  and  pains- 
taking character.  The  best  known  criticism  in  the  English 
language  is  probably  that  by  Hobson.  See  "The  Industrial 
System,"  p.  112  ff.  See  also  an  article  by  W.  M.  Adriance  in 
the  Quarterly  Journal  of  Economics,  November,  1904. 


THE  DEMAND  FOR  LABOR  157 

of  the  difficulties  raised  by  the  critics  only 
indicate  that  in  the  real  world,  in  place  of  the 
precise  calculations  attributed  to  the  employer 
by  the  productivity  theory,  we  find  only  guess 
work,  and  rough  approximations  of  what  is 
profitable.  It  is  not  proved  that  as  a  formu- 
lation of  tendencies,  of  points  of  equilibrium 
towards  which  economic  forces  work,  the  cal- 
culus of  the  productivity  theory  may  not  be 
accepted.  The  real  weakness  of  that  theory 
lies,  as  we  have  seen,  in  the  assumption  that 
employers  are  able  and  somehow  willing  to  pay 
either  the  full  value  of  the  marginal  product,  or 
this  value  discounted  according  to  some  inde- 
pendently established  rate  of  discount.  As  an 
account  of  what  makes  the  comparative  scales 
of  remuneration  for  labor  the  theory  may  pass 
muster.  It  does  not  give  an  acceptable  explana- 
tion of  the  absolute  earnings  of  labor,  that  is 
of  the  general  level  or  average  of  wages. 

This  concludes  our  critical  examination  of 
wage  theories.  Its  primary  purpose  was  con- 
structive, and  to  the  attentive  reader  the  positive 
results  are  already  apparent.  Stated  briefly 
the  theory  to  which  our  discussion  has  led  us, 
is  the  wages  fund  doctrine  modified  by  the 
conception  of  a  flexible  supply  of  labor  with 
a  gradually  rising  scale  of  supply  prices.  The 
assumption  of  a  temporarily  fixed  number  of 
laborers  made  by  the  classical  exponents  of 
the  wages  fund  theory,  is  no  longer  tenable, 


158  PROFIT  AND  WAGES 

because  of  the  part  played  by  immigration  in 
the  labor  markets  of  all  the  great  industrial 
areas.  The  conditions  determining  wages  today 
are  those  indicated  by  Figure  II  (Page  148). 
If  the  lower  curve  be  taken  to  indicate  the 
supply  prices  of  labor,  rising  as  the  quantity 
of  labor  is  to  be  increased,  and  determined 
chiefly  by  conditions  outside  of  the  capitalistic 
regions  of  the  world  and  by  the  expenses  and 
hardships  of  emigration  —  then  an  increasing 
wages  fund  will  be  divided,  not  among  a  station- 
ary number  of  workers,  but  among  a  supply  of 
laborers  increased  by  immigration. 

For  the  lowest  grades  of  unskilled  labor, 
the  prices  necessary  to  attract  an  increasing 
number  probably  rise  very  slowly.  The  supply 
curve  might  properly  be  drawn  so  as  to  run 
almost  parallel  with  the  horizontal  base  line 
for  a  large  part  of  its  course.  In  that  case, 
the  supply  price  would  be  the  chief  determinant 
of  wages  and  an  increasing  wages  fund  would 
result  in  an  increased  number  of  employes  in 
capitalistic  industry  rather  than  in  a  rise  of 
wages.  At  some  point,  however,  the  curve 
would  begin  to  turn  upwards.  Our  simplest 
formula  must  be  that  the  size  of  the  wages 
fund,  or  the  supply  of  capital  as  we  conceive 
it,  together  with  the  supply  prices  of  different 
quantities  of  labor,  determine  the  general  level 
of  wages. 


CHAPTER  IX 

CONCLUSION 

To  gather  up  the  results  of  our  inquiry,  the 
outline  of  the  problem  of  distribution  given  in 
Chapter  I  may  be  recalled.  The  first  stage  in 
the  analysis  was  that  of  the  division  of  product 
between  landowner  and  entrepreneur.  It  was 
pointed  out  that  where  there  is  product  in 
excess  of  the  marginal  rate  of  productivity,  this 
surplus  must  fall  to  the  landowner,  —  unless, 
as  the  result  of  superior  luck  and  ability,  it 
takes  the  form  of  a  differential  profit.  The 
second  stage  of  the  problem  was  the  determina- 
tion of  the  rate  of  profit,  profit  including  both 
the  income  of  the  entrepreneur  (exclusive  of 
any  differential  gain  he  may  obtain)  and  that 
of  the  capitalist.  This  rate  of  profit,  however, 
depends  on  the  division  of  the  marginal  product 
between  entrepreneur  and  laborer,  and  the 
problem,  therefore,  becomes  that  of  finding 
both  a  theory  of  profit  and  of  wages.  The 
character  and  the  terms  of  the  division  between 
capital  and  labor  constitute  the  most  contro- 
versial matter  in  the  whole  theory  of  distribu- 
tion. That,  however,  it  is  a  question  of  dividing 
a  marginal  product,  the  margin  being  thought 
of  as  both  an  intensive  and  an  extensive  land 


160  PROFIT  AND  WAGES 

margin,  has  come  very  near  being  generally 
accepted.* 

There  are,  however,  certain  ideas  which  have 
obtained  some  currency,  but  which  cannot  be 
fitted  into  this  formulation  of  the  problem,  and 
to  these  we  must  now  advert  for  a  moment. 
First,  we  may  take  note  of  a  disposition  to 
bring  land  under  the  concept  of  capital,  making 
rent  appear  as  a  part  of  the  share  known  as 
interest.  The  objection  to  be  made  to  this 
conception  is  that  the  total  supply  of  land 
cannot  be  increased  by  saving,  or  indeed,  by 
any  practicable  means.  As  the  amount  of 
capital  is  obviously  a  determinant  of  the  rate 
of  interest,  and  in  all  of  its  forms  other  than 
that  of  land,  can  be  increased  by  saving,  land, 
though  denned  as  capital,  is  left  standing 
outside  of  the  formulation  of  the  important 
factors  determining  the  income  of  capital. 
Additional  reasons  for  declining  to  subsume 
land  under  capital  can  be  found  in  all  the 
considerations  advanced  in  favor  of  viewing 
capital  as  subsistence  advanced  to  labor. 

We  may  note  next  the  theory  which,  pro- 
ceeding apparently  on  the  assumption  that  land 
is  variable  in  quantity,  regards  its  rate  of 
return  as  determined  by  the  specific  product 

*We  need  not  consider  at  length  the  views  of  those  who  deny 
the  existence  of  no-rent  land.  Provided  rent  as  a  return  above 
that  on  an  intensive  margin  is  recognized,  that  is  provided  the 
concept  of  a  margin  is  accepted,  there  is  no  substantial  depart- 
ure from  the  formulation  of  the  problem  of  distribution  upon 
which  our  discussion  is  based. 


CONCLUSION  161 

of  its  marginal  increment.  It  is  not  opposed 
to  the  conception  of  land  rent  as  a  differential 
gain,  but  refuses  to  consider  this  differential 
character  as  anything  distinctive.  Wages  and 
interest,  it  is  argued,  may  also  be  viewed  as 
of  the  nature  of  "rents."  Add  successive 
"doses"  of  any  of  the  three  factors  of  production, 
-  land,  labor,  and  capital  —  to  a  fixed  quantum 
of  the  other  two.  Its  rate  of  return  will  then 
be  established  by  the  addition  to  total  product 
made  by  the  last  dose,  while  the  differential 
or  excess  of  the  earlier  or  intra-marginal  doses, 
falls  as  a  "rent"  to  the  other  two  factors,  those 
thought  of  as  fixed  for  the  time  being,  and  as 
being  dosed  by  the  factor  in  question.  Each 
share  in  distribution  can  thus  be  made  to  appear 
both  as  a  marginal  return  and  as  a  rent. 

This  "law  of  the  three  rents"  is,  of  course, 
a  complicated  form  of  specific  productivity 
theory,  and  the  difficulty  already  confronting 
this  theory,  of  demonstrating  a  specific  product 
for  labor  and  one  for  capital,  is  greatly  aug- 
mented when  it  becomes  necessary  to  impute 
something  to  a  third  factor.*  All  the  objections 
which  may  be  made  to  the  specific  productivity 
theory  may  be  made  against  this  variant  of 
the  theory.  Furthermore,  as  land  is  often  fixed 

*To  add  a  fourth  factor,  the  services  of  the  entrepreneur,  and 
to  think  of  this  as  applied  in  doses  and  rewarded  according 
to  its  marginal  productivity,  does  not  increase  the  difficulties 
of  an  already  overtaxed  theory  of  imputation,  but  is  open  to 
other  objections.  See  Edgeworth,  "The  Theory  of  Distri- 
bution," Quarterly  Journal  of  Economics,  February,  1904. 


1 62  PROFIT  AND  WAGES 

in  quantity  and  almost  never  capable  of  con- 
siderable increase,  except  in  the  form  of  no- 
rent  land,  the  variability  of  this  "factor  of 
production"  assumed  by  the  "law  of  the  three 
rents,"  is  in  conflict  with  facts  which  the 
economists  may  not  disregard.  Of  course,  a 
particular  establishment  or  industry  may  secure 
additional  amounts  of  rent-bearing  land.  It 
can  do  this  if  it  can  extract  a  larger  return  from 
the  increments  of  land  in  question  that  was 
obtained  in  the  enterprises  from  which  the 
land  was  withdrawn.  In  other  words,  advan- 
tageous rearrangements  of  productive  forces 
are  possible.  Such  changes,  however,  have 
nothing  to  do  with  the  shifting  of  the  entire 
productive  margin  which  the  specific  produc- 
tivity theory  pictures  as  resulting  from  increased 
or  decreased  supply  of  a  factor  of  production. 
Unless  the  total  supply  of  rent  bearing  land  is 
capable  of  considerable  increase,  the  dosing 
principle  of  determining  a  specific  rate  of 
return  is  not  applicable  to  land.  The  total 
supply  being  practically  fixed,  the  return  to 
the  landowner  must  necessarily  take  the  form 
of  a  differential  gain,  of  a  product  in  excess  of 
that  resulting  from  the  marginal  investment 
of  the  variable  factors  of  production.  It  is 
only  by  falling  into  the  all  too  common  vice 
of  regarding  the  problem  of  industry  from  the 
point  of  view  of  one  particular  business  unit, 
that  one  can  reach  the  mystic  doctrine  of  the 
Trinity  of  Rents. 


CONCLUSION  163 

To  return  to  our  fundamental  assumption 
that  it  is  a  marginal  product  which  is  to  be 
divided  between  capital  and  labor,  we  found 
that  the  various  attempts  at  a  solution  of 
this  controversial  problem,  may  be  grouped 
under  three  heads.  In  other  words,  three 
methods  have  been  tried  in  the  attempt  to 
account  for  the  terms  of  the  division  of  product 
between  capital  and  labor.  First,  an  inde- 
pendent explanation  of  one  share,  either  wages 
or  profit,  the  other  being  treated  as  a  residual. 
Second,  an  independent  explanation  of  each, 
but  the  two  covering  the  entire  marginal 
product  —  the  productivity  theory.  Third,  the 
assertion  that  the  division  of  the  product  be- 
tween labor  and  capital  is  the  outcome  of  a 
struggle  —  the  bargain  theory. 

Commenting  on  these  in  reversed  order,  we 
may  say  that  the  bargain  theory  virtually 
gives  up  the  problem.  There  is  a  struggle 
between  employer  and  laborer,  and  the  com- 
parative aggressiveness  and  obstinacy  of  the 
contestants  may  largely  determine  the  out- 
come. The  problem  for  the  economist,  however, 
is  to  define  the  strategic  points  on  which  the 
contestants  base  their  demands.  What  alterna- 
tive has  each  party  in  mind  when  refusing 
the  terms  of  the  other?  To  call  the  process  of 
distribution  a  bargain  or  a  struggle  may  be 
unobjectionable  terminology,  but  does  not  ex- 
plain its  results. 


1 64  PROFIT  AND  WAGES 

The  second  of  the  three  methods  of  explaining 
distribution,  the  productivity  theory,  is  open  to 
various  objections  which  need  not  be  repeated 
at  this  point.  There  is  left  to  us,  therefore, 
only  the  method  of  proving  either  the  laborer, 
or  the  employer  to  be  the  residual  claimant.  This 
is  impossible  in  the  case  of  the  laborer  because 
the  return  to  capitalist  and  employer  cannot 
be  explained  independently  of  the  wage  earner's 
share.  The  time-preference  and  abstinence 
theories  cannot  account  for  the  rate  of  return 
for  capital  except  by  imposing  a  fiction  on  our 
minds.  There  remains,  therefore,  as  the  only 
apparent  solution,  the  demonstration  of  the 
scale  of  wages  as  independent  of  the  size  of  the 
product  and  of  the  share  going  to  capital. 
The  explanation  of  wages  propounded  in  the 
chapter  preceding  this,  the  wages  fund  theory 
supplemented  by  a  theory  of  the  supply  price 
of  labor,  satisfies  these  requirements  and  makes 
it  possible  to  represent  profit  of  capital  as  a 
residual  income. 

The  conclusions  reached  carry  us  back  to 
doctrines  of  the  classical  school.  They  include 
the  classical  concept  of  profit  of  capital,  in 
place  of  the  later  notion  of  profit  and  interest 
as  independent  shares;  a  residual  claimant 
theory  of  this  profit  not  differing  greatly  from 
Ricardo's;  and  the  wages  fund  theory. 

It  would,  of  course,  be  absurd  to  insist  that 
the  last  word  on  all  questions  of  distribution 


CONCLUSION  165 

is  to  be  found  in  the  pages  of  the  classical 
school.  Much  remains  to  be  corrected  or 
elaborated.  But  the  strategic  points  of  attack 
on  fundamental  problems  were  more  clearly 
perceived  by  Ricardo  and  his  generation  than 
by  the  majority  of  their  successors.  Not 
given  to  academic  refinements  and  subtleties, 
nor  led  by  radical  attacks  on  property  to  bend 
scientific  inquiry  in  the  direction  of  an  apolo- 
getic of  capitalism,  their  thought  moved  directly 
and  with  single  aim  upon  the  significant  and 
fundamental  features  of  the  industrial  system 
before  them.  So  far  as  later  developments 
shift  the  point  of  view  which  must  be  taken 
by  the  theory  of  distribution,  the  most  sig- 
nificant is  the  large  international  movement 
of  capital  and  labor.  The  part  played  by  immi- 
grant workers  in  the  advanced  industrial  areas 
of  today  makes  it  necessary  to  look  beyond 
the  narrow  national  boundaries  of  the  labor 
market  as  conceived  by  the  earlier  economists. 
In  our  theory  of  the  stipply  price  of  labor, 
recognition  has  been  given  to  these  changed 
conditions.  Other  products  of  economic  evolu- 
tion it  has  not  been  necessary  to  examine. 
The  growth  of  corporations  and  the  increasing 
complexity  of  what  Veblen  would  group  as 
"pecuniary  employments"  have  opened  fields 
for  investigation  scarcely  thought  of  by  the 
classical  economists.  The  analysis  of  these 
developments,  however,  is  not  an  essential 
part  of  the  "first  approximation,"  the  general 


1 66  PROFIT  AND  WAGES 

and  fundamental  theory  aimed  at  in  the  pre- 
ceding pages.  For  the  same  reason  we  may 
decline  to  discuss  the  problem  of  monopoly 
gains.  In  the  search  for  a  satisfactory  funda- 
mental theory  without  which  the  details  of 
an  inquiry  into  the  capitalistic  processes  of 
these  latter  days  are  without  meaning,  the 
classical  thinkers  are  still  our  best  guides.  The 
very  fact  that  they  are  free  from  the  perplexities 
of  later  developments  in  theory  and  practice, 
makes  them  a  valuable  propaedeutic  to  the 
study  of  the  problems  of  our  time.  But  this 
praise  is  only  for  their  scientific  work,  their 
unbiased  analysis  of  things  as  they  are.  Their 
political  ideals  and  attitude  towards  social 
reform  have  less  significance  to  our  generation 
and,  in  any  case,  are  irrelevant  to  the  present 
inquiry. 

The  considerations  which  have  led  us  to 
reject  a  large  part  of  the  fruits  of  more  recent 
theory,  are  stated  at  length  in  the  critical 
passages  of  the  preceding  chapters.  It  will 
not  be  necessary  to  recapitulate  them  at  this 
point.  Let  us  rather  take  note  of  certain 
general  tendencies  which  manifest  themselves 
in  almost  all  of  the  errors  into  which  modern 
theory  has  fallen. 

First,  there  is  the  excessive  rationalism  of 
the  utilitarian  calculus,  whose  pedigree  may 
be  traced  to  Bentham,  but  whose  greatest 
vogue  has  come  through  the  influence  of  the 
so-called  Austrian  school.  It  culminates  in  the 


CONCLUSION  167 

time-preference  theory  and  in  some  of  its 
phases  is  not  free  from  the  suspicion  of  an 
apologetical  Tendenz.  As  we  have  seen,  it 
attributes  to  savers  and  investors,  feats  of 
calculation  of  subjective  costs  and  gains  which 
are  utterly  impossible  to  mortal  man.  A 
psychological  turn  of  very  questionable  advan- 
tage was  thus  given  to  the  theory  of  distribution. 
It  seems  indeed  doubtful  whether  psychology 
will  ever  make  a  positive  contribution  to  the 
explanation  of  how  the  real  income  of  society 
is  distributed.  In  any  case,  the  application 
of  a  crude,  hedonistic  psychology  to  the  problem 
was  a  misfortune. 

Another  unfortunate  tendency  in  modern 
economics  is  the  consideration  of  the  problem 
of  distribution  as  essentially  included  in  the 
general  theory  of  value.  There  are,  of  course, 
analogies  between  the  purchase  and  sale  of 
consumers'  goods  (the  proper  theme  of  the 
theory  of  value  in  economic  literature)  and  the 
purchase  and  sale  of  the  services  of  the  "factors 
of  production."  But  the  problem  in  the  two 
cases  is  not  identical.  To  the  theory  of  value, 
commodities  appear  as  competing  for  the  con- 
sumer's favor.  Even  monopoly  products  com- 
pete because  the  competition  referred  to  is 
not  that  between  different  sellers  of  the  same 
commodity,  but  that  between  different  com- 
modities. The  problem  of  value,  in  other 
words,  is  that  of  the  relative  prices  of  goods,  - 
of  the  proportionate  amounts  of  money  and 


1 68  PROFIT  AND  WAGES 

credit  in  the  hands  of  the  consumers  assigned 
to  the  purchase  of  each  commodity. 

Now  can  this  way  of  looking  at  the  matter 
explain  the  remuneration  of  the  factors  of 
production?  In  trying  to  develop  the  analogy 
the  entrepreneur  must  evidently  be  assigned 
the  role  played  by  the  consumer  in  the  theory 
of  value.  Can  he  choose,  as  the  productivity 
theories  represent  him,  between  different 
"factors  of  production;"  as  the  consumer 
chooses  between  different  consumable  goods? 
If,  for  the  sake  of  argument,  we  accept  the 
idea  of  capital  as  consisting  of  "intermediate 
goods,"  we  have  three  factors  of  production 
which  the  entrepreneur  may  purchase.*  He 
needs  all  three,  though  the  proportions  in  which 
he  takes  them  might  vary.  So  far  the  analogy 
holds  between  demand  for  factors  of  production 
and  that  for  consumers'  goods,  though  there 
are  only  three  of  these  so-called  factors,  while 
consumable  goods  are  numbered  by  the  thou- 
sand. When,  however,  we  look  at  the  side  of 
supply,  important  differences  appear.  If  any 
factor  is  insufficiently  rewarded  it  cannot  change 
into  some  better  remunerated  factor.  If,  on 

"The  problem  becomes  very  perplexing  when  the  entrepreneur's 
function  is  represented  as  a  fourth  factor  of  production.  It 
is  something  not  purchased  by  the  entrepreneur  but  by  the 
consumers  of  the  products  of  industry,  and,  therefore,  does 
not  compete  with  the  other  three  factors  for  the  favor  of  the 
same  set  of  possible  purchasers. 


CONCLUSION  169 

the  contrary,  commodity  A  cannot  command 
a  satisfactory  price,  its  producers  can  turn  to 
the  production  of  commodities  B,  C,  or  D. 
The  insufficiently  remunerated  factor  of  pro- 
duction may  not  even  have  its  supply  dimin- 
ished. We  have  seen  that  in  the  case  of  capital 
there  is  likely  to  be  no  decrease  in  the  total 
supply,  but  only  a  slackening  in  the  rate  of 
increase.  In  the  case  of  labor  the  process  of 
decreasing  supply,  that  is  of  lowering  population, 
is  extremely  slow.  In  the  case  of  land  there 
is  no  possibility  of  diminishing  supply. 

Let  us  return  now  to  the  question  of  demand 
for  the  factors  of  production.  The  analogy 
between  the  remuneration  of  the  factors  of 
production,  and  the  payment  of  prices  for 
consumers'  goods,  vanishes  utterly  when  we 
reject  the  conception  of  capital  as  consisting 
of  intermediate  goods.  There  are  reasons  for 
regarding  capital  as  simply  the  means  of  pay- 
ment for  hired  labor.  Use  of  capital  means 
employment  of  labor.  There  is  no  choosing 
between  labor  and  capital  for  the  employer. 
He  buys  labor  by  means  of  capital.  The  choice 
apparently  existing  between  the  purchase  of 
labor  and  of  "capital  goods"  is  really  a  choice 
between  different  kinds  of  labor.  Instead  of 
having  three  factors  to  choose  from,  the  entre- 
preneur, therefore,  appears  to  have  only  two. 

But,  if  we  grant  the  existence  of  no-rent 
land  and  no-rent  margins,  we  have  the  possibility 


1 70  PROFIT  AND  WAGES 

of  dispensing  with  the  payment  of  a  price  for 
the  use  of  land.  Then  there  remains  but  one 
thing  to  buy  for  the  entrepreneur,  and  that  is 
labor.  The  entrepreneur  (and  the  capitalist 
acting  through  the  entrepreneur)  must  buy 
labor  and  it  can  be  bought  of  the  laborer  only. 
The  laborer,  in  his  turn,  must  sell  his  labor, 
and  it  can  be  sold  to  the  entrepreneur  only. 
Instead  of  competing  factors  getting  a  price 
from  a  common  purchaser,  the  process  of 
distribution  becomes  a  bargaining  between  two 
social  classes.  Both  of  them  must  ultimately 
come  to  terms,  although  the  compelling  forces 
on  the  two  sides  may  be  of  very  unequal  urgency. 
Such  a  bargain  may  be  covered  by  a  very  general 
and  abstract  theory  of  value  and  exchange, 
but  all  the  really  significant  and  interesting 
features  disappear  under  such  treatment.  The 
attempt  to  approximate  the  theory  of  distri- 
bution to  the  more  specialized  theory  of  the 
values  of  commodities  can  only  lead  to  con- 
fusion, and  should  be  abandoned. 

Like  the  excessively  rationalistic,  psycho- 
logical character  of  modern  economics,  the 
tendency  to  confuse  the  problem  of  distribution 
and  that  of  value,  is  also  largely  to  be  attributed 
to  the  influence  of  the  Austrian  theory  of  value. 
The  enthusiasm  with  which  the  latter  was 
received  caused  the  ready  acceptance  of  the 
analogous  reasoning  of  the  productivity  theory. 


CONCLUSION  171 

Indeed,  the  modern  theorist  felt  most  at  ease 
when  speculating  on  the  subject  of  value. 
Every  question  in  economics  had  perforce  to 
be  haled  into  this  field.  For  the  theory  of 
distribution,  however,  the  outcome  was  a  dis- 
torted perspective  and  a  failure  to  grasp  the 
significant  elements  of  the  problem. 


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